Enterprise Advisory

Keeping the Focus on the Role of an Endowment

Insights from Tracy Filosa, Co-Head of Enterprise Advisory at Cambridge Associates

Q: What is an endowment?

A: The conventional definition of an endowment is a pool of permanent funds for the ongoing support of a nonprofit institution; it is meant to last in perpetuity. Specifically in the case of most education institutions, an endowment is supposed to consistently support future generations of stakeholders, so it must be managed, spent and invested wisely. Endowment spending is designed to subsidize the institution’s nonprofit business model – making up for the gap between the cost of operating the institution and the institution’s other revenue sources, such as tuition. The bigger the endowment, the greater the support it can provide to the institution’s mission. In cases where endowment spending can cover over a quarter of the overall budget, schools are in a better position to fund research or offer financial aid and scholarships to a high percentage of the students. Endowments also typically cover ongoing costs, such as salaries, scholarship commitments and physical plant upkeep.

Q: How does an institution determine how much it will spend from the endowment?

A: How endowments get spent is based on contract or obligation, not on discretion or immediate needs. In most cases endowment donors are making a permanent investment in the institution around a particular program or mission that they are passionate about supporting. The institution commits to doing that, and if it spends too fast or redirects funds, it has broken its contract. In practice, a school’s endowment is really more a conglomeration of different funds than a single, nimble fund because the pool of money is made up of a number of gifts from various donors. Each donor has identified a purpose for spending its particular contribution and therefore a new endowment gift should not translate to more money to spend at will.

Q: Why do endowments grow beyond the initial value or corpus? (How big is enough?)

A: An endowment needs to grow to keep pace with the costs it is supporting, including ongoing costs that tend to grow each year. That’s why inflation must also be factored into growing spending needs. In most cases, a growing endowment makes an institution stronger. The notion that a large and growing endowment represents a hoarding of cash – that the institution is “over-endowed” – is a myth. Because most education institutions have long-term spending policies that outline consistent spending rates (perhaps 5% of the endowment’s value), a growing endowment means that it can play a bigger role and support more of the school’s goals over the long term. Institutions can work more towards their mission and be less reliant on tuition.

Q: Is an endowment a rainy day fund?

A: An endowment is not a reserve fund, rainy day fund or a special purpose fund. As previously stated, an endowment usually represents a series of contracts made up of capital that is supposed to be permanent. Therefore, institutions cannot tap into endowment on an as-needed, inconsistent, emergency or special-purpose basis. That would undermine the institution, and ultimately the endowment itself. In some cases, laws prohibit schools from doing so. There are other sources, such as a reserve fund or current use gifts that should be used for those purposes.

Q: How does an endowment fit into an institution’s budget?

A: We view the endowment as just one piece of a university’s financial puzzle. Diversifying overall university revenues – such as having non-endowment sources of income – can help institutions spend more now. Savvy institutions, particularly when they’re in a capital campaign, pursue conversations about the right mix of gifts to solicit, asking questions like, how much should we aim to raise for the endowment, and how much should we seek for, say, a construction project? At the end of the day, diversity of revenue sources leads to more solid footing.