A structure used by large non-profit organizations to raise donation capital
Written byCFI Team
What is an Endowment?
An endowment is a structure used by large non-profit organizations – such as hospitals, museums, and universities – to raise donation capital in order to fund its operations on an ongoing basis. The endowment structure enables such non-profit organizations to manage a set of financial assets through which investment returns can be generated. Investment returns that are generated from the financial assets are then used to fund the operations of the non-profit and further grow the endowment.
Capital is continuously added to the fund in the form of new donations and reinvested returns. The additional capital helps the endowment grow. Principal capital is generally never withdrawn from an endowment fund, which also adds to the growth of the funds. Only investment returns are used to fund operations of the non-profit organization.
Summary
- An endowment is a structure used by large non-profit organizations to raise donation capital.
- The purpose of an endowment is to earn investment income by investing the donated capital. Part of the investment income is used for operations and the rest is reinvested.
- The FASB classifies endowments into three categories – true endowments, terms endowments, and quasi-endowments.
Types of Endowments
Based on the Financial Accounting Standards Board (FASB), the three distinct types of endowments are:
1. Term Endowment
A term endowment, unlike most other endowments, is not perpetual. It is set up for a limited period of time, such as a fixed number of years or until a specific event such as the death of a donor takes place. After the term of the endowment expires, the contributed principal amount may be used to fund operations.
2. True Endowment
When a donor provides funds to the endowment, it is specified that they are to be kept perpetually. True endowments generally include a written agreement stating it.
3. Quasi-Endowment
The board of directors of an endowment fund may elect to use reserve funds, unrestricted gifts, or financial windfalls within the endowment fund. Such additions are classified as quasi-endowments.
The inclusion of the assets is at the discretion of the board of directors, and as such, a new board of directors may choose not to include such assets. Hence, it is not considered a true endowment.
Purpose of an Endowment
Because the primary goal of an endowment is to seek investment returns, the endowment operates as a fund. Once the endowment fund is mature enough, the distributions from the endowment can represent a large portion of the operating revenue for a non-profit organization.
For example, the Harvard University endowment fund, which is $38.3 billion in size, contributed as much as 35% to the university’s total operating revenue in the fiscal year 2019.
Donation Sizes of Endowments
The typical donation size of an endowment is generally much larger when compared to other charitable donations. It is because donors realize that large donations to an endowment are a way to fund the organization and support a cause they believe in for many years in the future, and hence their legacy as a donor is also kept alive.
Largest North American University Endowment Funds
Some of the largest university endowment funds in North America are listed below:
Taxation
Endowment funds get significant tax breaks, which acts as a catalyst to their growth. In the U.S., endowment funds do not need to pay taxes on any capital gains or dividends. However, an excise tax of 1.4% is levied on the endowment income generated by most American universities.
Additional Resources
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