Understanding and Measuring Endowment in Public Charities

Abstract

This note delineates different motivations for holding endowment by nonprofits, analyzes the definitions and measurement of endowment in the literature, and details newly available data on endowment contained in the Form 990 since 2008. More than 43% of organizations report owning an endowment, and the overwhelming majority of endowment funds are held by higher education nonprofits. One third of endowment funds are unrestricted and 41% are permanently restricted, with heterogeneity across subsectors. Endowed nonprofits exceed average payout rates each year of 5%. Annual endowment payouts average 4.1% of total organizational expenses, which measures the sector’s dependence on endowment revenue for operations. We evaluate past endowment measurement approaches using actual endowment data and find wide variation in validity. Although still imperfect, the new endowment data allow researchers to better understand a key distinguishing financial feature of the nonprofit sector.

Starting from scratch: Building of meaningful endowments by public charities

“…Assuming a 5% annual investment return for the endowment means that the organization could fund 10% ($100,000) of its operations in perpetuity with endowment earnings. This greatly exceeds the average ratio of endowment payouts to total expenses of 4.1% during the 2008–2012 period (Calabrese & Ely, ), but might be a reasonable threshold for smaller organizations.…”

“…The selection of investments equal to annual expenses is justified because such investments are expected to generate perpetual income “at least equal to 5% of an expense budget” (Bowman et al, , p. 567). The expectation of a 5% investment return for endowment funds is based on research and practice around the assumed safe spending rate to sustain an endowment corpus in perpetuity, reflects tax law setting minimum foundation payouts, is similar to guidance in UPMIFA, and parallels observed spending rates (Bowman et al, ; Calabrese & Ely, ) . The threshold of equal to or greater than 1 year of expenses also generates expected investment income sufficient to cover the majority of the mean depreciation expense of 5.4% for endowed 501(c)(3) organizations based on 2015 to 2017 tax filings.…”

“…Recent research confirms that most nonprofits lack an endowment and such wealth is concentrated in a relatively small number of organizations and subsectors (Calabrese & Ely, ). This paper investigates how common it is for a nonprofit to establish a material endowment.…”

“…The Uniform Prudent Management of Institutional Funds Act (UPMIFA) provides guidance to nonprofits in nearly all U.S. states on key issues related to managing endowment, including appropriate investments and determining payout rates; in general, laws and regulations around endowment differ by country. For organizations with endowment in the USA, the annual payout, or drawdown, averaged 4.1% of expenses in 2012 (Calabrese & Ely, ). However, payouts vary by subsector, with some far more dependent than others on these funds.…”

“…However, payouts vary by subsector, with some far more dependent than others on these funds. While hospitals only average 3.5% distributions, mutual benefit nonprofits average over 11% and arts organizations over 10% (Calabrese & Ely, ). Hence, endowment payouts support significant spending in many nonprofit subsectors.…”