The economic contraction caused by the COVID-19 pandemic has caused a cash shortfall for many companies and institutions.
The fall in revenues, combined with costs that cannot be quickly reduced, generates a need for additional capital. The availability of funds varies substantially across entities – and this variation can be even more striking during economic downturns. The most financially constrained corporations, who face the most urgent demand for funds, frequently find it most difficult to raise these funds. For nonprofits, the calculus can be particularly challenging. In many cases nonprofits have fewer options for raising capital than for-profit companies. This raises the critical question: what are the potential repercussions for these nonprofits? We highlight in this thought leadership series the fact that the simple ‘raise equity or raise debt’ does not characterize a realistic set of options for many organizations.
We begin our discussion with equity as a potential source of capital. Publicly traded companies have raised substantial new equity capital since the onset of the COVID-19 crisis. In fact, during May to August 2020, the number of publicly traded companies that raised new equity was over three times as great as during the same four months in 2019. For a nonprofit, the analog to raising equity is fundraising. Thus, at first glance it may seem that although nonprofits do not have stockholders in the sense of for-profit companies, they still have the potential to raise ‘equity’. From this perspective, can nonprofits “raise” equity when times get tough? In many cases, the answer seems to be ‘no’. Perhaps not surprisingly, charitable donations have been shown to be pro-cyclical, i.e., on average, during economic downturns, donations fall. For example, during the Great Recession, incoming donations fell by 7% for the average nonprofit in 2008 and again 6.2% in 2009. The ultimate financial impact of COVID on donations still remains to be seen, but current estimates suggest decreases that are either similar to or greater than those of the Great Recession.
The fact that a nonprofit cannot ‘raise equity’ (in the sense of greater fundraising), increases the importance of being able to access internal funds. For-profit companies generally maintain cash balances for such scenarios. The analog for nonprofits is existing endowments. Can nonprofits increase the draw on endowments or repurpose endowed funds to manage the crisis? Again, for several reasons, the answer seems to be, “No.”
First, not all nonprofits have endowments and thus, accessing endowments or analogous investments is a non-sequitur. Indeed, using 2017 tax return data, only 35% of nonprofits reported endowments or investment related assets. Moreover, the incidence of endowments varies considerably across nonprofit sectors. Both the percentage of institutions with endowments and the dollar amounts are concentrated within the education and medical industries.
Second, restrictions on spending endowments mean that nonprofits are often unable to spend these funds. Calabrese and Ely (2017) have found that most endowments—around two-thirds—have restrictions related to their use. Moreover, institutions often have defined caps on the percent of the draw from the endowment in any year, with any increase above that percentage requiring Board approval. Additionally, in some cases a large percentage of donations are donor-restricted, meaning that the assets can only be used for purposes defined by the donor.
Such restrictions are well intentioned: endowments are specifically created to guarantee the perpetuity of the institution and similarly, donor restrictions ensure the long-term viability of programs such as student scholarships or medical research. However, there may be serious unintended impacts of such constraints. These restrictions, meant to ensure the sustainability of the organization, may in fact threaten the organizations’ long-term viability.
Should these restrictions on endowment spending be relaxed? Without question, as highlighted above, these restrictions have benefits. However, it seems that the costs may exceed the benefits during certain periods. We argue that we may currently be in one such period.
Recent actions by some high-profile nonprofits support our argument. Several universities, including Stanford, Yale and Princeton, have announced plans to increase their payout from endowment funds as a way to handle the loss of revenues caused by the COVID-19 pandemic. For example, Princeton plans to increase the percentage of endowment value that it spends from approximately 5% to over 6% this year. The 6% rate is not sustainable: without growth, this higher spend rate would cause the entire endowment to be depleted within an estimated 26 years. But Princeton does not plan to maintain this higher spend rate for an extended period. It is a short-term fix to what is hopefully a short-term problem. And critically, this short-term fix gives Princeton flexibility during this critical period, flexibility that it otherwise would not have.
Unfortunately, many universities and other nonprofits do not have the flexibility that Princeton has. A greater portion of these organizations’ endowments are frequently restricted, meaning they cannot be used to support general operating needs.
We encourage all nonprofits and the funders of these nonprofits to recognize the uniqueness of the current times, and to recognize the value of financial flexibility as they navigate this period.