FAQs: Restricted funds and endowments

What are restricted funds and endowments?

A charity doesn’t always have the freedom to use its funds for its general purposes. Sometimes donors impose restrictions which limit the charity’s scope to use the donation freely.

There are two main restrictions.

Restrictions on purposes

A restricted fund is a fund which must be used for a particular purpose, rather than the charity’s general purposes.  So a charity might carry out a fundraising campaign for its work in a particular region. Depending on the terms of the fundraising literature, the funds raised might be restricted for use in that region.  A grant funder might make a large donation for a building project – that donation will be restricted to that purpose under the terms of the grant.  And a charity might receive a restricted legacy which can only be used for one aspect of the charity’s work – we’ve seen animal welfare charities receive legacies to support certain animals, charitable schools receive funds which can only be used for bursaries, and so on. 

Restrictions on spending capital

An endowment fund is divided into an income and capital element.  The original donation – the capital – must be invested to generate an income. The income can be used for the fund’s purposes – but the capital, including any capital growth, cannot be freely spent.  There are different types of endowment fund.  The capital of a permanent endowment fund can’t ever be spent – except under statutory powers in Charities Act 2011, which often require Charity Commission consent.  There’s more flexibility with an expendable endowment fund – here the capital can be spent, but only if the trustees of the fund make a positive decision to that effect.  And we often see hybrid endowment funds – where the capital can only be spent in certain circumstances.  So the terms of the fund might allow for a certain proportion of the capital to be spent each year, for example, or for the capital to be tied up as permanent endowment for an initial period after the endowment fund has been established and then converted to expendable endowment.  Endowment funds can be unrestricted, so that the income can be used for a charity’s general purposes, or restricted, so that the income must be used for narrower purposes. 

Why set up an endowment fund?

The appeal of an endowment fund is its longevity.  The charity can be assured of a source of funding well into the future.  And this has a significant attraction for philanthropists, who want to be confident that their donation will stand the test of time and will still be generating returns years down the line.

Endowment funds can also have religious significance.   The waqf (Islamic endowment) has been a central pillar of Islamic philanthropy for over a thousand years – Al-Azhar University in Cairo was founded in 975 CE through a waqf which has supported it ever since. 

We are seeing a move amongst charities to establish new endowment funds and invite their supporters to contribute, secure in the knowledge that their donations will be devoted to support for the charity in the longer term, and not spent on short term priorities.  We are also seeing philanthropists – particularly in the Muslim community – structure their giving as new endowment funds – knowing that their legacy will support future as well as present generations.   

The endowment fund can be designed to suit the charity’s or donor’s circumstances.  A degree of flexibility to spend at least part of the capital over time can give the charity comfort that there will be some scope to access the capital if necessary.   Individual donors may incorporate terms allowing advisory boards to influence how the funds are spent – and can build in scope for their families to serve on the advisory board down the generations.

The restrictions and inflexibilities of the endowment fund model are – our clients are finding – vastly outweighed by the donor’s desire to leave a lasting charitable legacy – and opportunities for charities to attract funds which can provide them with long term stability. 

How do we find out more about our existing restricted funds and endowments?

We can help our clients to check through their paperwork to establish the nature and extent of the funds they hold.   This is essential.  It’s not uncommon for the origins of restricted and endowment funds to be shrouded in mystery – or for misunderstandings about the terms of restricted and endowment funds to have developed over time – so that charities simply don’t know what they are for and how they can be used.

The accounts are a good starting point – although in our experience they are not always accurate.  And then you’ll need to carry out a review of your historic paperwork – including deeds, Wills, minutes, correspondence and fundraising materials. 

This should give you a fuller picture of the actual terms of your restricted funds and endowment funds.  Often this spring-cleaning exercise is all that’s needed to give a charity the confidence to understand how the funds can be used towards different aspects of its work.  But it will also identify whether the restrictions are preventing you from realising the funds’ full potential.

Is there scope to unlock restricted and endowment funds?

Yes!    A significant part of our work in this area is assisting clients to unlock restricted and endowment funds which may have lain dormant or unused for years.

Restrictions imposed many years ago can become out of date. The purposes of restricted funds may become inconvenient – or even obsolete – as circumstances change.  Endowment funds which previously generated a significant return may have become too small to produce a meaningful income. 

But there’s good news in that the Charities Act 2011 affords significant flexibility to release the restrictions, subject to statutory safeguards.  There are statutory powers to update the purposes of restricted funds – with Charity Commission consent.  There are also powers to access the capital of permanent endowment funds – including powers to release capital and to borrow from permanent endowment funds with Charity Commission involvement in some circumstances.  There are also powers to invest permanent endowment on a total return basis, and powers to invest in social investments which may not generate a financial return. 

We can support clients with understanding how the statutory powers can be used to greatest effect in their circumstances.

The material in this article is provided for guidance and general information only and is not intended to constitute legal or other professional advice upon which you should rely. In particular, the information should not be used as a substitute for a full and proper consultation with a suitably qualified professional. Please do contact the Bates Wells team if you require further advice or information about management training which we offer.