There is one type of endowment gift that is truly a joy to receive. This is one where a donor says, “Here is a bunch of money; invest it wisely and spend the income each year on whatever the institution needs.”
Although the size of the gift may be 20 times more than you can spend in the current year, the fact that the gift will produce annual income forever is a wonderful thing. If you encourage this form of giving over a long period of time, pretty soon the organization has a nice foundation of financial security. Sometimes, these types of endowments are referred to as unrestricted endowments because the income generated is not restricted to a specific purpose.
However, just as it is easier to raise funds for a specific purpose, so it is also easier to raise endowment funds with income restricted to a specific purpose. The university chair for a visiting professor produces annual income that pays the salary for a distinguished visiting professor. Another endowment produces annual income to subsidize an organization’s annual meeting while another fund accumulates annual income for major repairs. This type of endowment is sometimes referred to as restricted endowment because the income is restricted to a specific purpose.
The restricted endowment is one with which the donor and the development officer must be most careful. The charity’s annual spending policy specifies how much of the endowment balance is appropriated for spending each year. In accepting a restricted endowment, the development officer must take care not to accept a gift that produces more income than is needed to accomplish the specific purpose.
This is a difficult task for the average development director. Someone wants to donate $100,000 to an endowment with the income earmarked for X purpose; the charity’s 4 percent spending policy means that this donation will produce $4,000 per year to be used for X purpose. Suppose X purpose only costs $1,000 per year? What happens to the extra $3,000 that has been appropriated? This extra appropriated amount accumulates in temporarily restricted net assets restricted to X purpose. Over the years, this will just continue to accumulate, unavailable for spending on other costs of the charity.
What should have happened? The development director should have informed the donor that in order to endow X purpose, an endowment of only $25,000 was necessary. Of course, the risk is that the happy donor will believe he or she has just saved $75,000! Rather than watching $75,000 walk out the door, the development director needs to be ready with other, similar projects that can benefit from the donor’s financial support.
I have had development officers tell me that they are reluctant to get into too much detail with a donor holding onto a $100,000 check. They believe their job is to get that check into the charity’s endowment account as soon as possible. Understandable as this is, it is unfair to the donor and to the charity. First, the charity is not going to benefit from the additional funds because the annual income is restricted to X purpose, and unless the spending on X purpose increases 400 percent, that excess appropriation is just going to accumulate. Second, assuming this is a sophisticated donor (one who understands endowment giving), that donor is not going to appreciate that he or she was “sold” an investment at four times the price that it should have been.
This is not hypothetical. A real example, for which I was called in to consult, involved a school that received a $100,000 endowment gift with income restricted to providing a prize to the best math student in the graduating class. The school’s 4.25 percent spending policy produced $4,250 in annual income for this recognition gift. The school routinely spent less than $400 on the recognition gift. The school put the remainder of the annual appropriation into the general fund until the auditors discovered this one year and insisted that the school accumulate the unspent funds in a temporarily restricted fund for the math prize.
Eventually the donor discovered that his 15-year old gift was going largely unused. The school had both an upset donor and a growing, unusable fund. After much negotiation, a settlement was reached. What should have happened?
A basic foundation principal in restricted endowment giving is understanding on the part of the development office coupled with complete honesty and transparency in dealing with the donor. In this case, the development office first needed to know the cost of the annual senior student math prize as well as the school’s endowment spending policy. At that point, when speaking with a donor interested in encouraging math proficiency, an endowed senior math prize with an initial principal balance of approximately $9,500 could be discussed. Upon realizing that the donor had a larger donation budget, the development officer should be ready to roll out other programs that would benefit from the donor’s endowment investment(s).
Alternatively, a frank discussion of the “cost” of a “named endowment program"—the James Smith Senior Prize in Mathematics—which requires an initial gift of $100,000 designed to produce sufficient income for the annual math prize (approximately $400 in today’s dollars) as well as unrestricted income (approximately $3,850 in today’s dollars) for the school’s other programs would result in a program exactly as the school desires. The difference is that the gift instrument clearly indicates all of the facts and the donor understands what his or her gift will produce and where the money will be spent.
An endowment producing more funds than necessary is only one of the potential issues. The absolute extreme case would involve a charity that has an endowment producing income that it cannot use at all. Another situation affecting restricted endowment giving is the situation in which the charity evolves over time and is no longer is spending money in an area that is funded or partially funded by an endowment gift. My next post will provide interesting insight into just this situation.