The question every nonprofit CFO and board must answer: should you build an endowment fund?

Endowment funds allow you to diversify your portfolio and secure your nonprofit's future

For a nonprofit CFO, establishing a nonprofit endowment fund secures their organization's long-term viability by inviting donors to create a reserve that is used for investments. Having this financial safety net gives the board of trustees or directors greater flexibility and peace of mind while moving forward with their goals.

In some cases, the reserve may come from unrestricted donations the organization has received. These are funds that can be used at the nonprofit's discretion. This is in contrast to restricted endowments, when donors have given money toward a specific purpose.

Although the principal reserve cannot be used to cover other expenses without the donors' consent, it can be used to generate returns that can be put toward the nonprofit's needs. Generally speaking, the endowment fund should be at least two times your yearly operating expenses, according to Nonprofit Quarterly. However, the amount will vary based on the size of your organization and the scope of its work.

Why an endowment fund matters

A nonprofit endowment fund can serve as the foundation for ambitious new projects and hiring initiatives that enable the organization to massively expand its reach — and therefore its impact. Consider, for instance, the potential for funding in-depth, groundbreaking disease research. With a properly structured endowment fund, a nonprofit entity could back scientists and academics attempting to solve some of the world's most devastating health and well-being crises.

There are additional benefits as well. An endowment fund shows a willingness to commit time and resources to the cause, and it reassures donors of your longevity. It can also attract more contributors, who will see that other philanthropists have vetted the organization and believe strongly in it. That vote of confidence could inspire more giving. And, during economic downturns, an endowment can help your organization maintain its financial footing despite declines in donations.

Drawbacks to endowment funds

For all of their benefits, endowment funds aren't the right move for every nonprofit. While donor endowment gifts can be catalysts for strategic investments and wealth creation for the organization, you must take the long view with them. If your nonprofit struggles with cash flow, or is still in an early stage, having money in an endowment may be less valuable than gifts that can be used for immediate expenses or contributed to a cash reserve.

You'll also want to continuously engage endowment donors regarding the organization's progress and its ongoing needs. Once the endowment fund is set up, donors may assume the nonprofit doesn't need additional gifts. Educating donors about how different gifts are used and how the nonprofit's goals evolve may prevent you from suffering shortfalls.

Investments should align with your mission

Once your endowment fund is established, you'll need to devise an investment and asset management strategy. Likely that will include several different investment vehicles selected in cooperation with your trustees. You'll need to decide in advance on principles that will guide these decisions as well. Although the goal is to earn money for the organization, some investment opportunities may conflict with the nonprofit's values and mission. If your nonprofit is focused on responding to or mitigating the effects of global warming, for instance, investing in fossil fuels would contradict your mission.

It can be difficult to avoid such conflicts entirely if you opt to invest through index funds, because you may not know every company that's receiving your investment. But, you still have the option to avoid direct investment in companies whose activities are antithetical to your mission. You can also speak with an advisor about tailoring your index fund to ensure that you do not back companies that are misaligned with your nonprofit's values.

Depending on the size of your organization, a nonprofit CFO needs to decide how the fund will be managed. If your board is small or unwilling to take on full oversight responsibilities, you might opt to hire an outside firm to offer consultation and administrative support.

Endowment funds can be powerful assets if they are established at the right time and with a guiding framework in place. Consult with your executive team and board of directors to determine whether now is the time for your organization to create an endowment and integrate it into your long-term strategy.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of Silicon Valley Bank, a division of First-Citizens Bank and First Citizens BancShares, Inc. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein.