08/09/2010 08:15 am ET Updated May 25, 2011

The Endowment Conundrum

Ask any ten board members what would make their organizations more successful and nine of them will say, "All we need is an endowment." An endowment provides 'guaranteed income,' reducing the need for fundraising, and provides a measure of stability for the organization, they argue. Since private fundraising is such a scary concept for so many board members, and feels so uncontrollable, the concept of guaranteed income seems like a godsend.

Of course, I certainly would rather have an endowment than not have one. And if a donor offers me a sizeable contribution to our endowment fund I am, of course, extremely pleased and grateful for the largesse.

But there is a large difference between having an endowment and having fiscal stability, and certainly an immense difference between having an endowment and mounting an endowment campaign.

Endowments do not necessarily create fiscal stability. As we observed in this recession, one cannot depend on endowment earnings. When the capital markets crumble, endowments are worth far less and the income they generate falls proportionately. Those arts organizations that depend heavily on their endowments certainly suffered over the past two years. Just observe how major universities that have billions of dollars in their endowment funds are struggling at the moment.

But less obviously, I find that organizations with substantial endowments simply raise the level of their budgets to accommodate the investment income generated and don't routinely cut the level of contributed income they plan to raise. If an endowment generates $100,000 of revenue annually, the organization's budget is likely to rise $100,000 a year. In other words, arts organizations always grow to a point where they are uncomfortable. This is not necessarily a bad thing; it means we are more dedicated to pursuing our missions than to creating a period of fiscal relaxation. But it also means that the notion that endowments reduce the need for private fundraising is faulty.

And I would argue that an endowment campaign can actually cause fiscal instability. The cycle that healthy arts organizations enjoy stems from exciting art that is aggressively marketed. This allows the size of the organizational 'family' to grow, yielding larger amounts of revenue. When this revenue is invested in more and better art and marketing, the family continues to grow, revenue continues to rise and everyone is happy.

But when an organization decides to divert its attention and resources to an endowment campaign, this invariably means there is less money, during campaign years, to invest in better programming and marketing. As a result, the family does not grow, revenue does not continue to accelerate and fiscal health is placed in jeopardy. And the amount of endowment that must be raised to make a difference is so large since only 4-6% of its principle can be taken as income each year. It takes $3 million of endowment simply to produce $150,000 of annual income. Raising this amount while still raising the annual fund required to continue operations and produce great art is far beyond the fundraising capability of most small and mid-sized organizations.

Some organizations are so disciplined and well-managed that they can balance the needs of programming and marketing with the desire to build the endowment. But these organizations are few and far between.

The next time you hear someone say, "All we need is an endowment," think twice.