Managing Charitable Dollars

2. Endowments and Reserve Funds – Getting Started

For nonprofits of any size, having an endowment fund or a separate reserve fund can be helpful. Many organizations strive to establish both. An endowment fund earns interest and other income from its investments and can be a source of both steady revenue and long-term financial sustainability. A reserve fund is meant more for emergencies and to help manage cash-flow issues, but it can also help an organization save for the future.

If your organization wants to start an endowment or a separate reserve fund, this section is for you. If your organization already has an endowment but wants to do more with it in terms of impact investing, you’ll want to jump ahead to Topic #3.

Basic Terminology

In plain language, an “endowment” is a big pot of money that is not to be spent down, and that exists to generate income that can be spent. In Topic #1 we discussed two critical Board activities – approving the organization’s annual budget and investing its funds. Managing an endowment is one way Boards carry out these roles.

As explained below, endowments can be Board-designated or donor-established – but no matter how they are created, endowments are funds that are set aside, invested, and subject to spending rules so that the original funds invested (called the “corpus”) will grow and generate investment income that can be spent for the organization’s purposes. The important thing to remember about the corpus, which is sometimes called the “principal” – see below for the technical difference – is that it refers to the assets of the endowment, not the income those assets produce.

Understanding Restrictions on Funds

For legal and accounting purposes, endowment funds are either subject to donor restrictions or not subject to donor restrictions and can be used for any purpose the Board decides.  The difference is important for money management and reporting purposes.

  • Assets without Donor Restrictions are sometimes referred to as “unrestricted funds” and are are not subject to legally enforceable restrictions. This means the Board can use them for any charitable purpose. If an organization’s funds are simply set aside by the Board and are subject only to rules imposed by the Board (i.e., not by a particular donor), they are called “Board-designated endowments”; and for legal and accounting purposes, they are unrestricted funds. “Reserve funds,” if they are Board-restricted funds, are also typically unrestricted funds.
  • Assets with Donor Restrictions are sometimes called “restricted funds” because they have legally enforceable restrictions imposed upon them, either temporarily or permanently. Restrictions imposed by a donor (or as a result of charitable solicitations) are meant to limit the purpose and spending rate to preserve the original assets so that the fund can grow over time.
Starting Endowments and Reserve Funds

Endowments and reserve funds get started in different ways, depending on their type.

  • Board-designated endowments/reserve funds are funds set aside by the Board. To establish either one, the Board passes a resolution to create the fund and adopts an investment policy with the investing and spending rules for the fund. See our Sample Board Resolution for Establishing a Board-Designated Endowment. Or, to learn more about adopting an investment policy, go to Topic #6.
  • True, traditional endowment funds are usually started with the help of donors in one or more of the following ways:
    • The nonprofit launches a fundraising campaign to solicit funds from donors with the understanding (and the legally binding promise to donors in exchange for their contributions) that the funds raised will be restricted and invested in perpetuity for the purposes for which they were solicited. See our Sample Board Resolution for Soliciting Funds for a Permanently Restricted Endowment Fund.
    • The nonprofit enters into a written endowment agreement with a donor who would like to establish an endowment. See our Sample Donor-Designated Endowment Agreement.
    • The nonprofit accepts a bequest from a donor who died and named the nonprofit as a beneficiary in their Will with the understanding that the bequeathed funds would be invested in perpetuity.
    • A donor or a family creates a private foundation to carry out their philanthropic intentions, endowing it with the funding needed for grants and activities, often without additional fundraising.

The term “endowment” is not a legal or technical term, which means that it is not very precise and can lead to confusion – particularly as to whether the funds are subject to legal restrictions. But it is still handy and often used as a generic, conversational shorthand for funds that have been set aside and invested for the long-term. If your organization has what has been referred to as an endowment, take time to understand what that means and to locate and review the documents that established the fund to ensure you comply with any legally binding restrictions.

While the terms “corpus” and “principal” are sometimes used interchangeably, they have different technical meanings.

Corpus (coming from the Latin term for “body”) is the original dollar value of the seed-funding for the endowment and equals the total gifts received from a donor or donors plus any donor-required returns to principal (i.e., additions to the corpus).

Principal includes not only the original corpus and donor-required returns, but also nonmandatory reinvestments of unspent income and unrealized appreciation/depreciation.

For example, if a donor gives $1 million to fund a true, traditional endowment, with instructions that the income from the endowment be used to fund the annual operating expenses of the organization, that $1 million is the corpus of the endowment, which the Board may invest and withdraw the income from to pay expenses. If the total value of the investments appreciates to $1.5 million (after income has been withdrawn), the entire account balance is the principal, or the original $1 million corpus plus $500,000 in appreciation.

Regardless of whether you are talking about the corpus or the principal of the endowment, it is important to remember that these terms refer to the investment assets, not the income produced by those investments.