Taking Endowment Earnings: How Much Is Too Much?

02/04/2013 08:30 am ET | Updated Apr 06, 2013

While reading the financial reports of numerous arts organizations recently, I have been alarmed at how many of them are taking large percentages of their endowment as income each year. Most responsible arts organizations take between 4 percent and 6 percent of their endowments annually as income. This reasonable 'draw' -- that reinvests excess income in the fund -- allows the fund to remain productive for years and years and even to grow to cover some portion of the organization's inflation.

One large arts organization announced proudly and publicly that it had balanced its budget for fiscal year 2012. A closer look at the financial statements, however, showed that the same organization took 12 percent of its endowment as income that year! Yet it had only earned 3 percent on its endowment in the same period. This means, in effect, that 9 percent of its endowment principal 'disappeared' in only one year!

It is clear that the leadership of this organization was so intent on showing strong financial results that it leached its endowment of principal to do so. A simple calculation indicates that it would take about a decade for this organization to lose its entire endowment.

This is problematic for three reasons:

1. The donors to the endowment fund assumed that their gifts would benefit the organization in perpetuity. They assumed that a reasonable draw would be taken each year, leaving additional earnings (when there are any) to help the fund grow and provide a hedge in the face of inflation. Taking such a large amount from the fund, especially when earnings are so poor, is a violation of the trust of the donors.

2. The organization clearly faces fiscal challenges today but these challenges will only grow more serious as endowment income shrinks. The goal of any arts manager must be to make the future easier for the organization, not more difficult. I wonder if the board members of this organization are evaluating this draw carefully and assessing whether looking good in the short-term is worth future difficulties. The management of the organization may leave in a year or two, but the board will maintain responsibility for its fiscal health for years to come.

3. When an organization hides its fiscal challenges in this manner, it will often not take the proper steps to addressing them. This same organization has been over-drawing its endowment for several years. Expense budgets continue to rise and yet earned and contributed income are not keeping pace. The steps required to cut operating deficits -- creating astonishing art, marketing aggressively, welcoming new members to the organizational family and strict cost control -- are not being implemented. Has the staff and board engaged in a serious, honest discussion about the financial challenges and ways to address them? Or are they happy that they escaped another year without a deficit?

This organization, like many others, may announce a balanced budget today but a time bomb is ticking. I will be saddened, but not surprised, to read of serious financial problems, cutbacks, labor problems and the like in the relatively near future.