As the economic crisis drags on, Terrie Temkin discusses when it’s appropriate for nonprofits to turn to their endowments for cash.
First, I think it’s important to distinguish between reserves and an endowment.
Reserves are designed specifically to deal with the unexpected, for example the need for a new roof, the loss of an expected grant, or to settle a claim.
Typically, organizations keep enough available funds in a reserve to cover between six and nine – sometimes twelve – months of operations, making this the first place to turn during an economic downturn.
An endowment is designed to generate new monies for an organization through the wise investment of contributions. The principal is preserved and the interest is used – or left to grow – as determined by the conditions of the gift. (See Clarifying Endowments for additional information.)
These days, nonprofits are getting mixed messages about the use of their endowments. This probably is due to the fact that a number of different factors govern the expenditure of endowment funds.
The first is the original contract with the donor. Obviously, if the gifts to the endowment were restricted, you can only use the endowment funds in concert with the terms set out by the donor and accepted by the organization.
If the gift was given without strings, you might be able to use money in the endowment to cover a shortfall, but that depends.
It depends, among other things, on the current value of the endowment and the state in which your organization is incorporated.
Traditionally, nonprofits were never allowed to access their endowments if the value of those endowments fell below their historic, or original, market value as a result of the vagaries of the financial markets.
This was true even if a reasonable portion of those funds were legally committed to programs or projects in healthier economic times.
While about 40 percent of the states still prohibit the use of such depreciated funds, the majority of states have reversed course and adopted the new Uniform Prudent Management of Institutional Funds Act (UPMIFA).
This act was created specifically to ease the burden of an economic downturn. It allows people to dip into a fund – even if it has fallen below its historic dollar value – as long as they are prudent in their spending and make preservation of the endowment’s assets their top investment priority.
As Richard Slutzky, first vice president and senior philanthropic consultant with the Merrill Lynch Center for Philanthropy and Nonprofit Management reminds us however, even the charities in those states that have adopted UPMIFA should have their CPA and/or attorney review the application of FASB 117 that prohibits the invasion of “permanently restricted funds,” to see how it might apply to them.
Of course, an organization’s own investment policies must allow dipping into a depressed fund. And the board must understand the potential long-term impact of reducing the endowment before voting to approve such a measure.
This includes the very real possibilities that fewer people will be willing to make a commitment in the future to an endowment that can be raided and that the organization can become insolvent.
To find if your state has passed the Uniform Prudent Management of Institutional Funds Act, [click here.]
Terrie Temkin is founding partner at the Miami, Fla.-based management consulting group CoreStrategies for Nonprofits Inc. For five years, her “On Nonprofits” column appeared biweekly in the Miami Herald.