An endowment inculcates all the funds and donations a non profit entities received specifically to generate investment income. The principal balance usually stays invested for a long tenure or even permanently, and only the interest earned from it is used to fund the plans and programs, fulfil specific wishes outlined by the donor or cover operational costs.
Here is how endowment work and why entities opt to set them up.
MEANING OF ENDOWMENT
Endowments are assets for a non profit organisation which is received for charitable purposes. These funds and donations get invested in an endowment plan or fund and the earned income on these investments can be open on the operations of nonprofit’s. These are usually used by large organisations or institutions such as universities, colleges and health care entities. But they can also be used by museums, religious organisations, libraries and other not for profit entities.
A basic instance of an endowment will be a typical donation for a college. For example, DU has the largest education based endowment, It is used to generate investment backed income to pay for financial aid, scholarship and other purposes related to charity.
WORKING OF ENDOWMENT
NPOs such as hospitals, universities etc use endowments to build assets for the future. These can signal to the community that the organisation is stable enough and will have financial assistance in the long run. When an endowment is initially established, it generally comes with a set of guiding docs such as a corporate resolution or trust instrument from the board of directors that specify how the funds should be optimised. These docs may restrict the use of funds directly or indirectly. In some scenarios, it may state that a portion of the principal can be used each year.
The amount of income generated to the organisation through its endowment depends on the size of the endowment and how it is invested. For these reasons, some organisations hire an outside investment firm to actively manage the funds of the endowment. It may also have an investment committee or entire staff dedicated to maintaining donor relationships and increasing donations in the fund.
1. Term endowment:
A term endowment is a pool of investments where the principal can be utilised for a certain tenure. This term or tenure could be that a set number of years have competed, a specific event has occurred or a growth benchmark has been achieved.
2. True Endowment:
True endowments are the most generic type of endowment for universities and colleges. It is where all the endowment donations are pooled into funds and only the earned interest on the assets are utilised for spending.
3. Quasi Endowment
This is a pool of funds where the principal can be utilised as the institution's trustees see appropriate and fit.
MERITS OF ENDOWMENT
1. Helps an organisation grow and innovate:
Organisations with large endowment funds can implement innovative research programs, leverage its financial security to fuel long term goals and recruit prestigious employees.
2. Provide a continuous source of funding:
In many cases, an endowment asset stays invested permanently so an organisation can earn income in terms of interest year over year as a source of income.
3. Signifies good establishment:
Because endowments are perpetual and permanent, potential donors and the community will view it in a financially stable and well established organisation.
DOWNSIDES OF ENDOWMENT
1. Loss of real value:
If an entity spends all of the endowment earned interest every year, the real value will go down over time with the increased inflation.
2. It takes money and time to manage an endowment:
Entities have to hire people to manage investments and manage the relationship with donors.
3. Restriction of using the principal balance:
Unless it gets the required approvals and permission from the court or donor, an organisation can not ever touch the principal investment.