Endowment grantmaking: why and when?

Barry D Gaberman and Wendy Malina

In recent years, there has been increasing discussion about building endowment funds for operating organizations and for grantmaking foundations, both in the North and in the South. Endowment grants to operating organizations are often a recognition of a major advance in the organization’s growth and development. With grantmaking foundations in developing countries, however, many endowment grants are of necessity made to start-up organizations. In either case, endowments are too often seen as a panacea, and insufficient attention is paid to whether an endowment strategy makes sense. It is essential to ensure that endowment grants are appropriate for both the potential recipient and the donor.

There are many reasons, both financial and organizational, for creating an endowment fund. Financially, an endowment can provide a secure base of resources which partially alleviates the need for raising core support, reduces dependence on specific funding sources, and facilitates long-term financial planning. Organizationally, an endowment can create a sense of permanence that strengthens an institution and its stakeholders, enables increased attention to achieving long-range programme objectives, and fosters flexibility in working towards those goals. It may also serve as a catalyst for organizational change and as a fundraising mechanism to leverage additional support.

But endowment fundraising is costly and time-consuming. It requires detailed negotiations between recipient and donor over the fund’s terms and conditions, can interfere with an organization’s solicitations for project or core operating funds, often requires new skills and expertise, and may involve outreach to a wider circle of donors. Building an endowment also involves considerable risk, because it may not produce the revenue an organization needs.

Though most donor organizations do not make endowment grants, both public and private donors have increased their endowment grantmaking in recent years. There remains a need for discussion among both grantors and grantees about the merits and risks of pursuing an endowment strategy. This article looks at endowment building as a strategy to enhance organizational capacity and sustainability.

Endowments for operating organizations

The most important question when considering an endowment is whether a permanent need exists for a particular organization. An organization can outlive its usefulness. For this reason, donors generally make endowment grants in fields in which they have been active over a long period of time, and to organizations with which they have established relationships through core or project support.

The second question is whether a prospective recipient will benefit sufficiently from a fund’s income to justify the effort involved in raising and setting up an endowment. (In this article, we use the term ‘income’ to include not only dividend and interest earnings, the traditional definition of income, but also realized and unrealized capital gains and losses – that is, the total return on the investment.) While there are no ‘industry standards’ on the minimum level of an endowment, many in the philanthropic community suggest that a fund producing less than 10 per cent of an organization’s operating budget would not be worth the effort involved in raising the endowment.

Many organizations underestimate the size of endowment needed to generate a specific amount of income. They also misjudge the corrosive effects of inflation over the long term and fail to consider whether building an endowment will interfere with other fundraising. To preserve the real value of its fund, an organization must consider how much income it will spend and what portion it will reinvest in the endowment. The example in the box illustrates the tyranny of the numbers.

The tyranny of the numbers
Assume that an organization decides to build an endowment fund that will generate $1 million in general support. If it projects earnings of 8 per cent on the fund, it will need to raise an endowment of $12.5 million (.08 x $12.5 million = $1 million). However, if it also wants to ensure that its endowment fund keeps pace with inflation, perhaps as much as half the fund’s earnings must be retained in the endowment. In this case the organization will need to raise an endowment valued at $25 million (.04 x $25 million = $1 million), a daunting task.

If the tyranny of the numbers is not too intimidating, then ten key organizational and financial indicators are generally helpful in considering whether an endowment makes sense.  The organization will ideally have:

  • a track record of outstanding performance and of capacity to adapt to changing priorities and needs in its field over time;
  • strong leadership and experienced management;
  • a history of at least one successful leadership transition and board succession;
  • an active and diverse board that truly governs the organization;
  • financial stability during several previous years, with income at least equalling expenses;
  • fiscal accountability, with annual outside audits;
  • a diversified base of support;
  • evidence of board and staff commitment to pursuing an endowment strategy;
  • sufficient staff and other capacities to conduct an endowment campaign, manage an investment programme, and continue raising core and project support;
  • the potential to raise matching support from other donors.

When considering an endowment, an overall management review is highly recommended. Usually conducted by an outside consultant, this looks internally to assess an organization’s capacities and develop a clear picture of its strengths and weaknesses. Another useful mechanism is a feasibility study, which looks externally to analyse the donor community’s potential responsiveness to an endowment campaign, and to determine if the financial target, if realized, will yield sufficient income to warrant the time and resources needed to raise and manage an endowment.

Most of these issues apply equally to organizations located in the North or the South. However, it is also important to consider the grantmaking context in each country, specifically whether there is likely to be an understanding with regard to the purpose, fundraising process, governance, investment options, and spending policies for an endowment fund. Other issues include any legal, financial and administrative restrictions specific to a particular country that might affect the attractiveness of building an endowment.

Different types of endowment grant

It is often assumed that the only alternative to an endowment grant is a return to core or project support. This section outlines the different types of endowment, endowment-like, or endowment-related grants that might be considered.

General institutional endowment grant
This is held in perpetuity so that the purchasing power of the fund is preserved or expanded over time. Often paid in a lump sum, either as a contribution to an existing endowment or to start a new fund, it is invested to provide regular, predictable income for an organization’s expenses. As a general rule, these grants carry terms and conditions limiting a recipient’s access to a portion of the income generated by principal. Most prohibit recipients from using or borrowing against principal, and many carry matching requirements to leverage additional contributions.

Special purpose endowment grant
Rather than endowing the entire organization, this provides endowment funds for a particular effort of the organization, such as a programme development fund or a fellowship programme.

Endowment-like grants
These offer grantees access to flexible funding and are typically awarded when an organization is not ready to build or manage a formal endowment. They are also made to organizations that regard standard endowment grants as too limiting because of their restrictive terms and conditions. Endowment-like grants fall into two categories.Capital depletion grants make flexible funding available over a significant number of years (e seven to ten), usually for an organization’s general operations. They are paid up front in a lump sum so the organization may benefit from the investment of the grant funds. The entire amount of the grant is drawn down over the specified grant term, usually in equal instalments.Working capital reserve grants provide a source of funds to enable an organization to deal with an unexpected drop in revenues or unanticipated expenses.

Endowment-related grants
These offer support for specific activities aimed at enhancing a grantee’s capacity to raise and manage an endowment. They often provide a modest amount of funds, but they are one of the most effective ways to help a non-profit. They may help a grantee determine whether to pursue an endowment strategy by funding a management review or feasibility study. They may also fund the development of educational materials for a capital campaign, or support the campaign itself.

The special case of grantmaking foundations

While some of the above issues apply to grantmaking foundations, both private independent foundations and community foundations, there is one important difference. With operating organizations, their accomplishments over a significant time frame are an important criterion for endowment support. Given the dearth of grantmaking foundations in many parts of the world, an endowment strategy often means dealing with start-up situations. This adds both risk and complexity to the task. It is therefore appropriate to begin by asking why it is important to engage in this type of endowment building, followed by a discussion about what have we learned along the way.

Why create endowed grantmaking foundations?

Many see foundations as the building blocks of organized philanthropy. It is increasingly apparent that civil society organizations (CSOs) play crucial roles in building a vibrant and participatory society. Foundations contribute to this goal by enhancing the effectiveness and sustainability of operating CSOs.

Foundations can also assume leadership roles in problem-solving.  Especially on controversial subjects and in areas that generate conflict, they may serve as neutral convenors of diverse parties. Building a private or community foundation may also provide an important model of professional philanthropy in places where philanthropy tends more towards charity than development.

Finally, CSOs in a given country are vulnerable to both internal and external pressures if they are sustained largely with foreign funding. External pressures, because the priorities of foreign donors can change quickly; internal pressures, because the legitimacy of institutions supported primarily by outside funders is often questioned. Building indigenous grantmaking foundations is one powerful answer to this dilemma. Foundations are also attractive vehicles for capturing resources from internal and external sources, as well as from large diaspora communities, and for redirecting those resources to the needs of society. When the funds are provided by external sources, there is the added attraction of producing a modest transfer of wealth. General purpose endowments give foundations the flexibility to accomplish their tasks more effectively. (However, as the building blocks of organized philanthropy, foundations cannot accomplish all they are asked to do acting alone. During the past decade, foundations within countries, at the nation-state and regional levels, have increasingly formed networks and associations to enhance their impact.)

How to go about it

Despite the clear and compelling reasons for building endowed grantmaking foundations, achieving this goal is very difficult. Building a foundation is a long-term proposition. It is unusual for the time frame to be less than five years from the initial idea until the new institution makes its first grants. Those working on a foundation-building strategy thus need to be prepared to maintain their involvement. One of the first crucial tasks is to form an organizing committee. This must be done with great care because this committee will shepherd the effort from concept to institutional reality. Many committee members will ultimately be appointed to the foundation’s founding board, which will determine the foundation’s initial substantive focus and choose its first executive director.

Finally, there is a ‘chicken and egg’ issue that typically arises during a foundation’s start-up phase. Some feel that a foundation’s first task should be to concentrate on fundraising and build its assets. Others believe that building a grantmaking track record should be the first priority, and that this will facilitate a future asset-building strategy. Evidence suggests that these two tasks complement each other and that the most effective, but not necessarily the easiest, strategy is to work on both simultaneously.

Governance, investment and spending

When a non-profit acquires investable assets, it needs to manage them prudently. Responsibility rests with the governing body, usually the board of directors or trustees, which determines the investment goals, establishes a strategy for achieving the organization’s objectives within the terms and conditions set by donors, and evaluates its risk tolerance and internal capacity for implementing and monitoring investments. A board’s options include: delegating specific tasks to an investment committee or subcommittee; recruiting new members with financial skills; and seeking outside expertise.

The cornerstone of investment management is that a diversified portfolio always offers the safest combination of risk and return. The four most important investment principles are to:

  • set reasonable investment goals that avoid excessive risks or volatility;
  • balance the need for safety and growth;
  • monitor the performance of investments;
  • adjust the investment strategy in response to performance results and to changing market conditions and institutional needs.

If an endowment is to be held in perpetuity with the aim of preserving its purchasing power over time, a sound spending policy is crucial. This sets the percentage of investment income an organization may spend each year, and any adjustments it may make in response to changing circumstances, shifting market conditions and unforeseen developments. Written governance, investment and spending policies are essential to facilitate accountability, avoid misunderstandings, and safeguard against inappropriate invasion of an endowment.

Conclusion

It is important to end on a cautionary note. With operating organizations, endowment grants are most appropriately made to organizations with histories of outstanding performance and capacity, strong and experienced leadership, a broad base of support, an active and diverse board, and the capacity to manage and invest an endowment. They are not a good strategy for stabilizing a grantee experiencing difficulties. With grantmaking foundations, an endowment is the core mechanism for generating revenues to serve its programmatic goals. Endowment building for new foundations calls for long-term commitment to the new endeavour. The composition and involvement of the organizing committee, and balancing the foundation’s early fundraising and grantmaking responsibilities, are other crucial issues.

For both operating organizations and grantmaking foundations, building and maintaining an endowment requires vigilance in relation to governance, investment and spending policies and attention to fluctuating market conditions, ongoing core operating costs, changing institutional needs and, perhaps most importantly, the corrosive effects of inflation over time.

Barry D Gaberman is Senior Vice President at the Ford Foundation. He can be contacted by email at b.gaberman@fordfound.org
Wendy Malina is a Project Specialist at the Ford Foundation. She can be contacted by email at w.malina@fordfound.org

See also A Primer for Endowment Grantmakers: Endowment strategies to assist and enhance the work of nonprofit organizations (Ford Foundation, March 2001) and Laurence B Siegel, Investment Management for Endowed Institutions (Ford Foundation, 1999), both available at http://www.fordfound.org.


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