The Stefan Batory Foundation

Seminar on Legal and Financial Aspects of Endowment Building

Barry Gaberman, Senior Vice President, Ford Foundation

Endowment grantmaking: why and when?

THE PROGRAM OFFICERS' TOOLKIT

Project or Program Grants
Core or General Support Grants
Foundation Administered Projects (FAPs)
Program Related Investments (PRIs)
Recoverable Grants
Endowment, Endowment-like, and Endowment-related Grants

ENDOWMENT DEFINITION

An endowment is a fund held in perpetuity with the intent of preserving the purchasing power of the fund over time and the objective of making the institution's finances more stable and predictable.

INCOME DEFINITION

We will use the term "income" to include not only dividends and interest earnings, the traditional definition of income, but also realized and unrealized capital gains and losses -- that is, the total return on the investment.

THE TYRANNY OF THE NUMBERS

What size endowment would it take to have $1.0 million a year in general support and still preserve the purchasing power of the endowment over time?

@ 8% earnings per year you would need $12.5 million 
to yield $1.0 million.

(.08x12.5 = 1.0)

However, if half of the earnings must be retained in the endowment to preserve the real purchasing power of the endowment that would mean an endowment fund of $25.0 million would be needed to yield $1.0 million in general support.

(.04x25.0 = 1.0)

ORGANIZATIONAL AND FINANCIAL INDICATORS

A track record of outstanding performance and of capacity to adapt to changing priorities and needs in its field over time.
Strong leadership and experienced management.
A history of at least one successful leadership transition and board succession.
An active and diverse board that truly governs the organization.
Financial stability during several previous years, with income at least equaling expenses.
Fiscal accountability, with annual outside audits.
A diversified base of support.
Evidence of board and staff commitment to pursuing an endowment strategy.
Sufficient staff and other capacities to conduct an endowment campaign, to manage an investment program, and to continue raising core and project support.
The potential to raise matching support from other donors.

ALTERNATIVES TO A GENERAL INSTITUTIONAL ENDOWMENT GRANT

Special Purpose Endowment
1. For a program development fund
2. For a particular substantive effort of the grantee (i.e., fellowship program)
Endowment-Like Grants
1. Capital Depletion Grant
2. Working Capital Reserve Grant
Endowment-Related Grants
1. Management Reviews and Feasibility Studies
2. Capital Campaigns

LEGAL CONSIDERATIONS

If the applicant is not a 501(c)(3) nonprofit organization or the foreign equivalent of one, as defined by the United States Internal Revenue Code, an endowment grant cannot be made.
If the prospective grantee is a governmental unit, publicly-supported 501(c)(3) organization or foreign equivalent, an endowment grant may be made and expenditure responsibility need not be exercised.
If the potential recipient is a 501(c)(3) or foreign equivalent that is not publicly supported, expenditure responsibility must be exercised.
Reporting must continue for at least three years and until it is reasonably apparent to the Foundation that the principal of and the income from the endowment grant are being used for proper purposes and in accordance with the terms of the grant notification letter.

LEGAL CONSIDERATIONS (continued)

As with any other grant, it is also worth noting the following:

If funds are used for exempt purposes other than those specified in the grant letter, the Foundation must take all reasonable and appropriate steps to recover the diverted funds or to insure their restoration to the purposes of the grant, or the grant must be modified to make it consistent with the expenditure of the funds.
Finally, if endowment funds are used for a non exempt purpose, the amount could become a taxable expenditure to the Foundation. This could lead to the imposition of a penalty tax, unless the Foundation remedies the situation by taking all reasonable and appropriate steps to recover the funds or to insure the restoration of the diverted funds and any other grant funds to the purposes of the grant.

POTENTIAL FUNDING SOURCES

Foreign and Domestic Public Donors
Foreign and Domestic Private Donors
- Individuals
- Foundations
Foreign and Domestic Corporate Donors

BE CLEAR ON ANY MATCHING CONDITIONS

What matching ratio (e.g., one-to-one, two-to-one) will be selected?
What will count toward the matching requirement?
How will the funds be released (in a lump sum up front, or periodic payments as matching funds are received)?
What will be the time frame for meeting the matching requirements?
What will happen if the grant funds are not fully matched?
How long will reports be required?

FUNDRAISING POINTS TO REMEMBER

Soliciting donations from local communities or target constituencies.
Soliciting grants through "diaspora" fundraising to reach people who have moved across local and national boundaries.
Preserving an organization's base of support by maintaining a focus on the continuing need for general support and project funding for ongoing operations.
Follow-up is essential, because soliciting larger contributions always requires several meetings and conversations.

INVESTMENT COMMITTEE TASKS

The development of an investment strategy;
Recommendations concerning asset allocation so as to conform with the spending policies and the level of risk tolerance established by the board;
The preparation of written investment policies and guidelines;
The selection and monitoring of the fund managers or other investment vehicles;
Periodic reviews of the investment program's progress in order to ascertain whether it is meeting its objectives and to determine if the asset mix continues to be appropriate in light of changing market conditions and organizational goals; and
Oversight to ensure the timely receipt of reports by fund managers, and compliance with written investment guidelines, as well as with the terms and conditions set by donors.

FOUR INVESTMENT PRINCIPLES

To balance the need for safety and growth
To set reasonable investment goals
To monitor the performance of investments
To adjust the investment strategy in response to performance results and changing market conditions

INITIAL INVESTMENT CONSIDERATIONS

Spending Policy - the dollar amount or percentage of assets that may be spent per year, and the adjustments that may be made as circumstances change (e.g., the receipt of additional contributions unusually high or low investment returns, etc.);
Asset Allocation - a target percentage or ercentage range in each of the principal asset lasses e.g quities, bonds, cash) that is consistent with the purpose for which the funds are invested; and
Fund Structure - the number of investment management firms to be engaged and other related issues.

ASSET CLASSES

Stocks (Equities), Principally Include:

U.S. Stocks
International Developed Country Stocks (Western Europe, Japan, Canada, and Australia
Emerging Market Stocks Fixed-Income Investments:
U.S. Bonds (Treasuries, Mortgages, and Corporate)
High-Yield Bonds
Non-U.S. Bonds
Inflation-Linked Bonds
Cash Reserves

DETERMINING SPENDING POLICY

Balance two competing goals:

The need to preserve and grow the real value of assets, adjusted for inflation.
The ability to distribute or expend sufficient unds to meet a fixed amount of core operating costs or project

expenses.

Example 1

An organization decides to build an endowment that annually generates $100,000 in income.

If this organization achieves an 8 percent return on its investments and elects to spend the entire amount of income generated by the fund, it will need to build a $1.25 million endowment:

.08 x $1.25 million = $100,000

In this situation, the organization's asset base would remain at $1.25 million year after year, and the real value of the fund would decline annually at the current rate of inflation. Even if this fund continues to generate $100,000 in income, inflation would similarly erode the real value of the $100,000 in income year after year.

Example 2

For the same organization with an endowment of $1.25 million, assume:

that inflation stands at 4 percent; and
that the organization realizes an 8 percent return on its investments.

If half its $100,000 return is reinvested in the endowment to maintain the fund's value against inflation, then only $50,000 would be available for the organization to spend on programs and administrative costs. The organization's asset base would be protected, but the organization would not be able to generate the amount desired for its operations.

Example 3

If this organization projects an 8 percent return on its investments and decides that it wants to spend $100,000 each year and to preserve the real value of its fund, it must build an endowment of $2.5 million to realize $200,000 in income:

.08 x $2.5 million = $200,000

A fund at this level would enable the organization to spend $100,000 and to reinvest $100,000 in its endowment fund, thereby protecting its asset base.