Understanding Endowments for Nonprofit Leaders  

An overview of endowments and why they matter

Endowments play a powerful yet often misunderstood role in the long-term financial health of nonprofit organizations. For nonprofit leaders, understanding how endowments work and how they can be responsibly managed ensuring responsible management can unlock opportunities for financial stability, donor confidence, and mission longevity.

What is an endowment?

Far more than a savings account, an endowment is a carefully stewarded pool of donor restricted assets invested to support a mission for over the long term. Typically, the principal is meant to be preserved, although not in full, while investment earnings are used annually. By preserving principal and using investment earnings to fund programs year after year, endowments provide stability, credibility, and resilience even when fundraising fluctuates or economic conditions shift. It is best to consider this as a financial tool that is designed for sustainability, not short-term liquidity.

Types of Endowments

Endowments come in three forms, each with distinct rules and purposes that impact how funds can be used and managed. Understanding these categories and the nature of an endowment helps guide effective financial decisions and ensures both donor intent and organizational flexibility are considered.

True (Donor Restricted) Endowment

• The donor stipulates that the principal must be maintained permanently gift is to be endowed and subject to the organization’s endowment policy.
• The use of funds is governed by donor intent and the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Each state independently adopts UPMIFA through its individual legislation.

Board Designated Endowment (Quasi Endowment)

• Funds are set aside by the board, not the donor.
• The board can remove or redesignate these funds as needed.
• It is still important for governance but not legally restricted or restricted for financial reporting purposes.

Term Endowment

• The principal may be spent after a specific time or event.
• Restrictions are donor defined but temporary.

Why endowments matter

Endowments provide stable and predictable funding for organizations, ensuring that programs and operations can continue regardless of fluctuations in fundraising cycles. This financial stability supports long-term planning and helps maintain program continuity. Additionally, having an endowment signals financial strength and credibility to potential donors, grantors, and lenders, enhancing the organization’s reputation and capacity to attract further support. Endowments also serve as a protective cushion during economic downturns, helping organizations weather periods of financial uncertainty.

How endowments are used

Most nonprofits establish a spending policy to guide the responsible disbursement of endowment funds. These policies typically define key metrics such as the percentage of funds to be spent and the basis for calculation, often setting annual spending at 4–5% of a rolling average market value.

Nonprofits must carefully balance the need for current program support with the goals of protecting against inflation and preserving the purchasing power of the endowment over time. Spending decisions should always align with donor intent and the standards of prudent management, with thorough documentation of policies and procedures to ensure consistent and compliant implementation.

Underwater endowments

UPMIFA guidance emphasizes prudence, not preservation at all costs. Spending an endowment below its historic gift value is permitted, provided the spending is done within the organization’s spending policy.  Therefore, underwater endowments occur may arise when the fair value of the endowment fund drops below the original gift amount contributed by the donor. In such cases, UPMIFA permits spending from the endowment if it is deemed prudent under the circumstances, but it requires that the organization properly disclose the situation. Maintaining strong governance practices and thorough documentation is essential to ensure compliance and transparency when managing underwater endowments.

The keys to successful endowment management are documentation of policy and implementation of processes to ensure policies are followed. Endowments can feel complex, but you do not have to navigate them alone. Contact your Opportunity Advisor or Email | Call: 804.747.0000.

Starting an Endowment: Key Considerations and Pitfalls to Avoid