Episode 259: Endowment Restrictions by Donors or by the Board - How to Create the Proper Options for Both
I can't tell you how honored I am that you would take a few minutes of your day to join me, Randall, on this edition of A round with Randall. We want to talk today a little bit about endowments and an interesting issue that's come up with a client. And it was really spurned this conversation by an email. I kind of ironic.
The two kind of met in the same place to bring us to today from Jim in California. I want to thank you for listening. What about this concept of endowments and the challenges that come with endowments when there are restricted funds versus quasi endowed funds? Is there one that's better? Is there one we should aim for? What are the ups downs, negatives, positives in dealing with this?
So really we want to take this apart and see if we can help with some of the answers that would help guide you into these endowment conversations. We need to start with why endowments are so important. I've been advocating for most of my career, in part because of kind of the way in which I began my philanthropy fundraising career, where I had a mentor talk about this, about the importance of the endowments in the institution that I worked for in the time a secondary educational institution that then, with my education expertise is too strong a word, but certainly my interest in the plain giving space, you begin to see where endowments become really important.
This was amplified both during the Great Recession from 2008 or 9 to about 2013, but certainly during Covid, as well as those became funds that people could fall back on. What we know is, is that with the great transfer of wealth that's going to occur anywhere between 80,000,000,000,090 or, excuse me, 80, 80 trillion to $90 trillion, depending on, you know, whether you look at Merrill Lynch or Cirelli or somewhere else.
We're talking about the largest transfer of assets in the history of the world happening in the United States in the next 20 to 25 years. On top of that, we know with inflation in some uneasy, at times economic, moments or indicators that people are being a little more conservative with their dollars and that we know more transformational gifts will be done through playing, giving with the content, thought process or understanding that a number of people, certainly ones that I've worked with both in my days as a practitioner, but now even into my days as a consultant, once clients ask me to come back, I talk to some of their donors to figure out
the challenges. Situations may be answers to what they might be able to do. They're not gonna leave it all to the kids, which brings and elevates nonprofits to a higher state. We know that this is going to be, at least I truly believe can be the future of nonprofit organizations. Those with endowments are going to be the ones that survive and thrive, and the ones that don't are going to be the ones that struggle and demise or disappear.
What's the advantage in having these endowments? Well, first and foremost, it's financial stability and predictability. The more you're able to control those costs through a strong endowment, meaning that a certain percentage of your expenditures is covered by some type of endowment, that that investment income that comes from invested funds that are going to be there in perpetuity. This allows for operational planning.
It also allows for kind of an interesting strategic investment that comes from being able to take new dollars and put them in places you may not have thought of, because you have an endowment to generate dollars for basic needs in education. That's faculty chairs, like university started many years ago, and certainly scholarships in health care. It's dealing again with chairs, but it could also be patient assistance.
It could be funded depreciation for a number of places. We're now even seeing endowments for people who may leave like $10,000, which we'll talk about the value of that in a moment, $10,000 so that they can continue an annual giving process of $500 per year or feel like that. That's what they could continue based upon their love of the organization.
The second thing is, is it brings great institutional strengths.
Places with large endowments have the ability to make decisions that are sometimes evolutionary, sometimes revolutionary in terms of what they want their organization to be, what services they provide, what they are really meaning to execute this institutional strength because it can be so large. If you look at take the largest Harvard, they can do whatever they want when somebody pushes on them as an example here, maybe recently and or they want to look at a critical, maybe not revenue positive investment that's going to make their organization or institution stronger.
They have institutional strength through those endowments to do so. They can weather storms better. Harvard being at the top. Well, if you are a $15 million nonprofit. So Harvard's at one side, but, you know, at billions. And that could be a health care system. But let's say you're an independent school or you're a food bank. 15, $20 million a year, a $100 million endowment producing, you know, somewhere could be $5 million or so per year.
That's 25% of your operational budget. That gives you institutional strength. It gives you the opportunity to innovate, to program, develop, to have operational capacity to serve your mission. The third thing is, is that places that have larger endowments are psychologically stronger to donors. No donor wants to be the funding mechanism that barely keeps the doors open, at least maybe not more than once.
You might be able to get away with that once. But Harvard also raises the most amount of money, and they have the largest endowment. And by the way, if you look at the statistics places, the larger endowments raise more money because donors feel as if that innovation. And we talked about this in multiple podcasts, I talk about that with my clients.
Transformational giving comes from impact. Well, if you have that institutional strength and you have that financial stability that you can take new dollars, invest it into incredibly impactful things because the organizational structure is taken care of through or at least partially through endowments. That's that example, $100 million endowment for a $20 million operational budget. Nonprofit brings you $5 million.
That is incredibly opportune for donors to think about, how do we get to a $25 million organization, what is needed to build out whatever the service might be? So building out endowments is critical. Now we get into how to do it, at least at the maybe 20 or 25,000ft level. What was I talking about in this quasi endowment or permanent endowment discussion or question from Jim in California?
At the top of the podcast, there's a distinction, a legal one, a quasi endowment is one that the board has instituted based upon funds it has available that aren't restricted to other purposes permanently established endowment is one that most likely a donor has established, and it has a very specific purpose. Quasi endowments can be changed. Permanent endowments technically can be changed, but the implications are totally different.
A quasi endowment fund endowment fund can be changed by simply a board vote to reverse it. A permanently endowed fund, most likely with a gift agreement. You got kind of two options. You can go back to the donor or the donor's family and get them to write off on the change, meaning they okay it or you have to get a court involved.
And let me tell you, that is not something you want to do. The reason this has come up, ironically from the question. And then also, as I mentioned, the client that I'm dealing with is, is that sometimes funds that are established 20, 30, 50, 75 years ago, all of a sudden aren't able to be used in the same way as they were established.
And so classy endowments provide several different options or maybe rationales as to why they're better. Number one, they provide flexibility without compromising discipline. Meaning if you're quasi endowed, we can change it to what we need today. Number two is, as I mentioned, the speed to make these changes. If you have to go to court, I don't think that's going to be fast.
And a family could say, you know, mom and dad or grandma and granddad established that fund. Now, I'd be remiss if I didn't draw the distinction between core needs and ancillary needs. If you're a university, you're always going to need scholarship money. So whether that is quasi in doubt or permanently in doubt may not make much of a difference unless the restriction on the permanently endowed is such that it's only good for left handed blond haired.
Males from the eastern part of Texas, and all of a sudden you don't have any of those. Those funds are going to be wasted or seat just seated in that endowment. The more restrictive the endowment, the more it's probably opportune to have them be quasi endowed because it gives you flexibility. And that's what I was talking about, about the speed of decision making and flexibility.
So this is where we have to work with our donors to come up with better or the best options. We want endowments, but we want them to be wide enough that we have flexibility to use them, and not too narrow that we can't ever not be able to, you know, apply them in a meaningful way. We'll talk about that here in just a moment.
The third is, is that from the why quasi or better is it aligns with long term missions and we just mentioned the scholarship example. There's a lot of different ways to spin this. Maybe you're a food bank. You've got an endowment to bring in food for a certain part of the city. But over 50 or 75 years, that part of the city reinvents itself, and all of a sudden it's now industrial, where there's nobody living there.
You want the food endowment, but you need it broad enough that it's not going to restrict you if the circumstances change. That's that better long term alignment with mission. Another is, is that it protects the organization from what I would think of as donor overreach, where donors are trying to control certain aspects of the organization. Example made up completely.
But a law school takes on a massive endowment, but the endowment pushes the law school toward a particular part of the law that they're not interested in really serving, i.e., maybe it's a trial based law school, meaning most of the lawyers come out and they're going to be trial lawyers or headed to court. But donors like but I want it to be all tax.
And that donor overreach can push the organization into places it may not want to go or that's not in its best interests. And that's why we have to be careful with these completely, completely legitimate and well intentioned but permanent endowments. Are they mission aligned over the long term? So let's talk about this idea of why these things might change.
So we've talked about a couple of them and I'll just highlight them maybe a couple of others or bigger thoughts. It might be worth the conversation. Number one is is that our program needs change. So if you established some type of funding mechanism for only physical textbooks for students who can't afford them, physical textbooks meaning the programmatic nature of education has changed.
My son doesn't have a book. He's got an iPad. Everything's on there, it seems. Well, that's a point where programs change. How we offer classes is another example. Well, this is only meant for students sitting in the classroom. Wait a minute. How many classes do we now offer online? And so it changes when we change our program needs.
We want the resources that fit that general description to go with it. You have too many permanent endowments that are too restrictive. That's hard to do. Number two is, is that the inflation and cost structures of the organization has changed. Think about a scholarship fund as an example that says, we're going to fund one student scholarship or one nursing fellowship or something of that nature in 1985.
But inflation has grown so much that all of a sudden that fund doesn't provide that entire scholarship. Now, what another is administrative burden. If you have all of these heavy restricted funds? Again, I'm for endowments. I'm just advocating, number one, can they be quasi. And number two, can they be not so restrictive that they put a chokehold on the institution, but administrative burdens, a third one that we've got to manage all of these accounts.
They got to go out to the right people. We've got to do the right reporting. The more of the small endowments that you have, the more challenge there is in administering them. Number four is kind of a thought of legal complexity and donor intent issues. And that's where our gift agreements need to be more defined. Actually, the client that I'm working with, this was exactly what we're going through.
Is it literally endowments established 35 years ago. We were on one sheet of paper and they weren't really defined very well. And there was a lot of interpretation. What does the board mean by that? What was the gift agreement? Well, it was incredibly short. It threw three paragraphs. One case. There was no gift agreement. What was the intent board?
Quasi endowed funds normally have some type of record in the board minutes, which is highly advantageous. You know exactly what they were thinking. If you don't document these things in the right way, it causes legal complexity potentially down the road. So what are some examples of pitfalls that we need to avoid. So things like outdated program endowments, micro endowments with narrow purposes, as we've talked about, if the lots of small endowments that have very specific individual needs and or applications to be used for scholarships or endowments with very narrow eligibility that left handed, blond and eastern Texas.
But your universities in Massachusetts. Oh what happened? We don't have anybody. The other is technology. And this one has become more of a particular issue with endowments over the last 15 to 20 years, because if the restriction is such that there are formats or light, let's use the example to funds and endowment to fund the computer lab. We don't have computer labs anymore.
Everybody's got their own individual device, so much so they might have 2 or 3. Well, what do you do then? The point is, is that if you can do quasi endowment, meaning your board has resources at its disposal, that it can put into a quasi fund that's going to fund exactly what's needed in that moment, that board can change it down the road.
And that's something like the client that I was referring to actually had a positive outcome, which we were able to figure that out and say, well, no, no, no, you can move that money. The board just needs to vote on it. We just need the documented appropriately. But the second part of it is not being too restrictive with the other permanent endowments that if you create too many of them, it's an administrative burden.
They're not large enough, they don't make the impact or they restrict access to the funds. They're too narrow. Then they can't be used. These are all things we've got to talk about with our donors, which is the last 30s here. If somebody wants that left handed blond from Texas to go to school in Massachusetts, can we have the kind of conversation to explain that the intent is remarkable and beautiful and makes our mission, but that restriction might preclude us from actually providing it?
That opportunity, that scholarship, because we don't have anybody. What if we just pulled it back and said, can we get rid of East Texas and left handed and blunt? How about people from Texas? Because my guess is, if you're a university, depending on your size, there's probably pretty good chance you have someone from Texas. That's a conversation we have at the front end with the donor before a permanent endowment is established.
That's our responsibility to make sure, if nothing else, I would call it the ethical responsibility. We have to make sure that a donor's dollars are used the way they want, not just today, but if it's a permanent endowment forever, which means we need to talk about these things, we can't be just satisfied to say, oh, we got the gift.
Yes, a gift really going to be used. Is it going to be meaningful in 20, 30 and 50 years? If we're not asking that question, then we're failing our donors as well as our organization. With the potential changes in the world and whatever the organization does to meet those changes on the quasi end outside, this is critically important that in your board minutes that you are incredibly detailed as to what was done, why it was done, and what the purpose was and how much money was initially quasi turned out.
There can be other funds that are added to that quasi endowed fund, and those actually become permanent by law. But it's the donor intended to be in that fund. But that initial fund, plus its growth, can be changed in the future. The only way that can be done is, is if there's a right minutes and declaration of purpose, intent, the vote, all the things that our minutes should have.
And by the way, that's what saved my client is I started going back through the minutes and found the minutes from 1995, where there were 2 or 3 pages of details about creating a quasi endowment, which was not being used, needed to be changed. They weren't sure how to do it, but the board at the time and by the way, whoever was the recorder, the secretary or the staff member who did it, thank you.
I could go back and say, look, here are the minutes. Here's the original amount plus interest over that 30 years. Here's how much money is actually available to be moved to a different purpose. That would be much better for the organization today. So whether it's quasi and out and the records or permanently in doubt and having the right conversations with our donors, this is a critical thing to do to make sure endowments can be used well into the future.
And at the end of the day, that's the biggest purpose not to over restrict and to make sure to document so that the organization can use these unbelievably, generously given funds to maximize the mission that donors gave the money for originally. Hopefully this gives you a context to think about it. A little bit about your funding. Maybe go back and figure out what parts are quasi endowed versus endowed.
The point is, is if you have the right conversations and you talk about it, the opportunity to do it, the right way, it's right there in front of you. You control it. And that's going to make yourself today. But generations to come of people in the organization happier and able to serve the mission in the moment based upon the needs of that moment.
Don't forget to check out the blogs at Hallett Philanthropy two per week 90-second reads. Really surprised how many people are reading nowadays. The blogs I'm honored, but they're there for your purpose, to give you something to think about, things I read, things I feel see deal with things that maybe not quite the size of podcast, but for seconds might give you something to think about.
If you'd like to reach out to me like Jim did today, please feel free to do so at podcast@hallettphilanthropy.com. If you have a subject you want more information, let me know. I'm glad to always have information and an opportunity to talk about it. What you do is critical. It's serving a need in the community that not just the mission in the organization, but you as a board member or a CPO.
A major gift officer, infrastructure annual fund. It's special. That's whatever it is. Volunteer. You are making a difference. And that brings me to my favorite saying. Some people make things happen. Some people watch things happen. Then there are those who wondered what happened. Nonprofit work. Philanthropy is all about people making things happen for the people and things in our community that are wondering what happened, what a great way to spend a professional career, and I hope you feel that way.
I hope you understand and take a moment every day to realize the impact that you're making on a lot of people and a lot of things that are wondering what happened. That's got to be very gratifying and hopefully realized by you every day. I'll look forward to seeing you the next time, right back here on the next edition of Around with Randall.
And don't forget, make it a great day.