What is an endowment? – Large non-profit organizations need donation capital from time to time in order to fund their operations on a daily basis. Hence, these large organizations make use of endowments as financial tools. With this tool, various non-profit organizations can manage a set of financial assets to generate investment returns. They use these investment returns to fund the operations and further grow the endowment.
In this article, you will learn about endowments in general and how it works. Apart from that, we will also take a look at its major features and purpose. Furthermore, we will give you an idea of the different types of endowments. Finally, we will look at the major pros and cons of endowments. Hence, to learn more about endowments, read on through to the end of the article.
What Is An Endowment?
According to Investopedia,
“An endowment is a donation of money or property to a nonprofit organization, which uses the resulting investment income for a specific purpose. An endowment can also refer to the total of a nonprofit institution’s investable assets, also known as its “principal” or “corpus,” which is meant to be used for operations or programs that are consistent with the wishes of the donor(s).”
Mainly, large non-profit organizations design endowments to ensure that their principal amount is intact. At the same time, these organizations use the investment income for charitable efforts. They also ensure that the organized endowments are a trust, private foundation, or public charity.
The organizations that administer endowments include educational institutions, service-oriented organizations, and educational institutions. They manage their endowments with the goal that when donors provide funds for the purpose of the organization, there are sufficient resources to support that purpose.
How Does Endowment Work And What Are Its Purpose?
According to Wall Street Mojo,
“The endowment funds are funded mainly by way of donations. The funds have specific policies concerning investments, withdrawal as well as usage of the funds. Normally the policies allow that the initial investment, known as the principal, shall remain untouched, and only the investment income can be withdrawn for use in the operations of the non-profit organization.”
Organizations use endowments as a trust, private foundations, or public charities. In general, educational institutions like universities and colleges administer endowments. On the other hand, there are other types of endowments too. Bodies like cultural institutions and service-oriented organizations manage these types of endowments.Indexed Universal Life Insurance: What Are They And How Do They Work?
In some cases, the organization can also use a certain percentage of endowment assets. Hence, the amount that the organization withdraws mostly consists of a combination of principal and interest income. Based on the prevailing market rates, the ratio of principal to income of the organization will change on a yearly basis.
Another important aspect of endowments is their management. It is a discipline unto itself, and managers have to deal with the push and pull of interests to use assets. They set objectives, assess business risks, develop policies of payout, build asset allocation policies, select managers, define responsibilities, and cut costs.
What Are The Types Of Endowment?
The following are the major types of endowments:
1. Unrestricted Endowment
It consists of assets that the organization can spend, save, invest, and distribute. This endowment is at the discretion of the organization.
2. Term Endowment
As per this method, the organization can expend the principal only after a certain event or a period of time. However, after the time limitation that the donor had imposed is over, the organization can freely utilize the fund.
3. Quasi Endowment
This is an endowment donation that the organization receives from an individual or an institution. The individual or the institution gave the fund for a specific purpose. The organization that receives the fund retains the principal and extends or distributes the earnings as per the instruction of the donor. Institutions that benefit from such endowments start this through internal transfers.
4. Restricted Endowment
In this system, the organization holds the principal in perpetuity. At the same time, the organization expends the earnings of the invested assets as per the specifications of the donor.
When it comes to donation size, The Corporate Finance Institute states –
“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.”
What Are The Pros And Cons Of Endowment?
The following are some of the major pros and cons of endowment:
Pros Of Endowment
Here are the major pros of endowment:
- Organizations are in a better position to attain their objectives as the funds act as financial support.
- Professional managers manage the fund and take due care to ensure its protection.
- These funds act as a regular source of income for the organization or institution.
- The organization gets additional support for the annual fund of the organization.
- The organization can also utilize the funds’ proceeds for various programs.
Cons Of Endowment
Here are the major cons of endowment that you need to be aware of:
- The organization can use certain contributions for limited purposes only. These include the ones that are for specific purposes.
- The organization can also face restrictions while withdrawing funds. This can lead to hampering of operations.
Hope you have an understanding of what is an endowment and how it works in general. In the United States and also in other parts of the Western world, you will find endowments with academic institutions. The size of the endowment of an academic institution shows how well-off the institution is. This shows that the institution can fund its operating costs.However, the organization that is receiving endowments cannot violate the terms of endowments. If an institution has gone bankrupt but still has assets in endowments, then a court can issue a “cy pres doctrine.” This allows the institution to use endowment assets for better health. If you have more information to add, share it with us in the comments below.
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