Foundations & Endowment Funds (2022)

So you are thinking about establishing a Foundation or an Endowment Fund.This article takes a look at some of the reasons why, what these terms mean, what’s involved in establishing and operating, some pros and cons, and some other things to think about.

You may be an existing charity looking to do more and wanting to enhance the longer term financial and operational sustainability of your good organisation.Alternatively, you may be a philanthropic individual wanting to establish a more formalised legacy for your charitable giving.Either way, establishing a Foundation or an Endowment Fund are popular strategies.

However as with any new endeavour, and especially one that will likely involve ongoing compliance obligations, and may even involve establishing a separate legal entity, we suggest it is important to firstly pause and:

  1. be very clear of your objectives
  2. understand and consider the main options and implications; and then
  3. develop your strategy and act.

With reference back to an earlier article "Please don't set up a new NFP entity!" New Zealand already has an extraordinarily high number of not-for-profit and charitable entities.Especially when considered in light of our relatively small population.Hence, it is imperative that any decision is a considered and well-thought through strategy, rather than just “a good idea at the time”, or reacting to the causal, and possibly well-intentioned but sometimes ill-informed, suggestions of others.

Video: Where Are Endowment and Foundation Allocations Shifting Next?

What’s the difference between a Foundation and an Endowment Fund?

In our experience the words are often (incorrectly) used interchangeably.Yet there are some important differences.Hence it is important to understand these to ensure the correct vehicle is used and to avoid any unintended consequences.

A Foundation(also sometimes called a charitable foundation) is a term generally used to describe a separate legal entity with a principal purpose to typically donate funds and support other charitable/not-for-profit organisations.Alternatively, it may exist to provide the source of funding for its own charitable purposes.While not-for-profit in nature a foundation is usually concerned to maximise the revenue generated from its capital while also balancing adherence to a specified risk appetite to ensure protection of the underlying capital invested.

The legal structure of most foundations in New Zealand is that they are incorporated as charitable trusts under the Charitable Trusts Act 1957.This of itself does not mean they are charitable though as under New Zealand law an entity is now required to register with DIA Charities Services under the Charities Act 2005 in order to be granted registered charitable status.Being recognised as a registered charity provides it with benefits of income tax exempt status as well as a degree of public credibility.

Video: How our endowment works

An Endowment Fundis an investment fund established by a foundation or registered charity whereby capital is set aside to support the organisation or a specific project or purpose.Most endowment funds are structured so the principal amount invested remains intact, while the investment income is available for the purpose that the fund was established for.

An endowment fund could technically be established by a profit seeking corporate but as such it would not have any tax advantages and hence would be unlikely to attract any significant gifts or other support.

The main difference from a foundation is that an endowment fund is not a separate legal entity.But rather, it is an internal fund of an existing entity i.e. a fund established within an existing legal entity, usually a registered charity.You can think of an endowment fund as a bank account within an organisation established for a specified purpose.

Video: What is an Endowment?

Endowment funds may be restricted or unrestricted with the restriction specified by the original donor of the funds.The funds of the unrestricted variety may be used in any way the recipient organisation chooses whereas restricted endowment funds may have limitations put in place over them by the original donor.A common example is a university scholarship where the funds are to provide income to fund scholarships in a specified area of study.

A highly variable feature of endowment funds is the level of formality applied to them.This can range from very little to highly detailed internal rules and requirements specifying in great detail the fund’s purpose and how it will be operated and reported.

Foundations – Pros and Cons

Pros

  • A separate legal entity – this can assist with ring-fencing funds from potential attack as opposed to those funds being just seen as part of the funds of the larger operating charity.
  • Provides a greater degree of protection and certainty that the capital won’t be redirected due to any short-term whims or cash-flow needs of the beneficiary charity.
  • Separate charitable registration is possible and hence can assist in making it very clear to donors what any donated funds are for and are to be applied to.

Cons

  • A separate legal entity – hence has a legal life of its own and all of the establishment requirements, ongoing administration, compliance and governance that goes with that – effort and cost.This will include amongst other costs; separate financial statements, audit if it is large enough, and Charities Services filing compliance.
  • Separate governance can occasionally prove problematic due to the governing body sometimes diverging from original establishment intentions.Especially challenging if the foundation deviates from supporting the organisation it was originally established by and intended to support.
  • Depending upon how the Foundation is established and operates then it still may be considered under accounting rules to be a controlled entity of the beneficiary charity.As such its financial statements would need to be consolidated into the financial statements of the beneficiary charity.This can prove problematic when a Foundation is established with an intention of specifically separating the optics of the main charity’s funding.

Endowment Funds – Pros and Cons

Pros

  • Not a separate legal entity – this saves on unnecessary costs or duplication of costs
  • Flexible as generally just a decision of the governing body to ring-fence part of their funds for a specific purpose and use.Formality of this can vary but is ultimately under the governing body control and as such they can generally change as they see fit.
  • Part of the host entity’s charitable registration.Hence the host can still potentially fundraise in the name of the endowment fund and for its specific purpose as long as they still clearly disclose the registered charity details.Donors still get the benefits of donating to a charitable entity and should be able to receive a charitable deduction.
  • Can be a good way to highlight, profile, and ring-fence, a fundraising project of an entity.
  • Doesn’t need to produce separate financial statements by law as is just part of the host entity’s operations.

Cons

  • Not a separate legal entity – hence if the charitable entity is attacked then the endowment funds may be legally exposed as part of the entity’s overall available funds.
  • As it is in effect just a bank account of the charity then there is the danger that its funds may be diverted by the governing body for short-term needs.i.e. is within their decision-making ability to change.
  • May be more difficult for the charitable entity to demonstrate to third parties why it needs more funds if its endowment fund is a part of its overall financial statements and this gives it the appearance of having significant available funds.
  • Can be viewed by some as less likely to attract significant gifts than a separately governed legal entity such as a foundation – however this is debatable and can be a function of quality of communication only.

Community Foundations – another sensible alternative?

Recent years has seen a rise in the establishment, promotion, and growing support of community foundations in New Zealand.These have proven themselves a successful model overseas and with good reason.In essence, they are a charitable fund aggregator that utilise economies of scale to provide a cost efficient investment, administration and funding vehicle.

Video: How Endowments Work

As we have noted above, to establish a separate foundation as a separate legal entity and registered charity involves a reasonable amount of skill, effort and ongoing compliance and governance. The basic philosophy behind the community foundation movement is that a motivated donor can instead donate to a specialist organisation like a community foundation which is itself a registered charity, specifying wishes of what their donation should be used for.As the community foundation is managing a number of funds they can get synergies and better returns from their scale and skills and the donor benefits from this.Most community foundations also allow a range of flexibility depending upon the donor’s wishes.For example some donors may wish to establish a fund within the community foundation in their name, whereas others may be happy to add to an existing special purpose fund that appeals to them.Some donors may be quite specific with where/to whom they wish to donate.Others may wish to only donate income from their original donation, whereas others may wish to donate a mix of capital and income, or for this to change over time.

There are a growing number of these now established in New Zealand such as the Acorn Foundation, the Auckland Foundation, the Nikau Foundation to name a few.The growing maturity of this sector is such that there is now a Community Foundations of New Zealand organisation established and you can visit their website for more information;www.nzcommunityfoundations.org.nz

For individuals and families, donating via a community foundation can be a very sensible choice given the value of a specialist structure and professional best practice skills in managing them.This is a choice that can ensure both effectiveness and efficiency of donating.

Video: How Harvard and Other Colleges Manage Their Endowments

Alternatively, a small charity without the capacity and scale to efficiently and effectively operate either a separate foundation or endowment fund of its own may potentially want to consider establishing a fund within a community foundation for ongoing support.

Summary

As can be seen above there are advantages and disadvantages to any choice of action regarding establishing foundations or endowment funds.The key is to be very clear on what your aims are, be aware of the main implications and then to seek appropriate legal and accounting advice to ensure your choice meets your aims.

Click hereto continue to read this article written by myself andCraig Fisher -originally publishedonrsmnz.co.nz. If this article is of interest to others please feel free to share.

Video: Why Endowments and Foundations Value Active Investment Strategies

FAQs

What are endowments and foundations?

An endowment is a pot of donated money that is invested to create a reliable stream of annual income for a charitable purpose. For nearly all private foundations, endowed funds are the primary sources of their giving. Some public charities also have endowments, most commonly in the arts and in higher education.

Do foundations have endowments?

Endowments tend to be organized as a trust, private foundation, or public charity. Educational institutions, cultural institutions, and service-oriented organizations typically administer endowments.

What are the 3 types of endowments?

Based on the Financial Accounting Standards Board (FASB), the three distinct types of endowments are:
  • Term Endowment. A term endowment, unlike most other endowments, is not perpetual. ...
  • True Endowment. When a donor provides funds to the endowment, it is specified that they are to be kept perpetually. ...
  • Quasi-Endowment.
Aug 14, 2020

What is the meaning of endowment fund?

An endowment fund, quite simply, is money set aside (invested) to earn revenue to fund some type of charitable activity. Unlike a typical investment fund, the beneficiary of an endowment fund is a nonprofit organization instead of individual investors.

How do foundations fund themselves?

Unlike a public charity, which relies on public fundraising to support its activities, the funding for a private foundation typically comes from a single individual, a family, or a corporation, which receives a tax deduction for donations.

How does endowment fund work?

Endowed funds differ from others in that the total amount of the gift is invested. Each year, only a portion of the income earned is spent while the remainder is added to the principal for growth. In this respect, an endowment is a perpetual gift.

Are private foundations endowments?

Private foundations make grants based on charitable endowments. The endowment funds come from one or a small handful of sources -- an individual, a family or a corporation.

Where do foundations invest their money?

Similar to private equity investing, foundation donors make investments in private companies or venture capital funds — the difference being that these investments go beyond mere financial returns to provide social and economic benefits.

What is the difference between nonprofit and a foundation?

Foundations. Foundations are organizations that did not qualify as public charities. They are very similar to nonprofits, except money for a foundation usually comes from a family or a corporate entity, whereas nonprofit money often comes from their revenues.

Who manages an endowment fund?

Organizations with larger endowments may seek investment management from private investment counselors or banks. Selected for their expertise in endowment, long-term asset management and fiduciary oversight, these partners often work only with nonprofits of sizeable endowments ($5 million or larger).

What is the difference between endowment and donation?

An endowment accepts donations, and they're usually created for a specific purpose. Unlike many other charitable donations, organizations with endowment funds do not spend the donations themselves. Instead, they use an endowment fund as an investment tool.

What is the purpose of endowments?

Endowments allow donors to transfer their private dollars to public purposes with the assurance that their gifts will serve these purposes for as long as the institution continues to exist. Endowments serve institutions and the public by: Providing stability.

What is an example of endowment?

An example of an endowment is a scholarship fund that has been set up in memory of a deceased person and that funds the education of students. An example of an endowment is when a person makes a gift of money to support a university or other cause.

Why is an endowment fund important?

A well-managed endowment sends a message of planned long-term stability, fiscal responsibility, and financial viability. It enhances the organization's prestige and credibility. Relieves pressure on the annual fund.

How do endowment funds invest?

Endowment funds are initially invested by donors for certain charitable purposes. They are usually established as trusts, which keep them independent of the organizations that they support. Endowment funds consist of cash, equities, bonds, and other types of securities that can generate investment income.

Is a foundation a nonprofit?

Broadly speaking, a foundation is a nonprofit corporation or a charitable trust that makes grants to organizations, institutions, or individuals for charitable purposes such as science, education, culture, and religion.

Do foundations pay taxes?

Private foundations are exempt from federal income tax because they are charitable or “section 501(c)(3)” organizations. This means that the foundation's investment earnings, capital gains and certain other types of income are not subject to income tax.

What can a foundation invest in?

In most circumstances, a private foundation is permitted to hold not more than a 20% ownership interest in a business enterprise. For purposes of these rules, in the case of a corporation, “ownership interest” means voting stock; in the case of a partnership “ownership interest” means capital interest.

Videos

1. Seth Godin on Successful Fundraising - Ask the Fundraising Expert
(Amy Eisenstein)
2. Inside Look at Endowment Funds with Investment Director Greg Dowell, CFA
(Invest Like a Billionaire)
3. Webinar: The Hidden Risks of Fixed Income for Endowments & Foundations
(ManningandNapier)
4. Wealth Strategy - Private Family Foundation
(kelvin harris)
5. Endowment Fund
(KYC Bytes)

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