Borrowing Against Restricted Funds: A Strategic Guide for Nonprofits

Nonprofits today face intense financial pressures, constantly balancing the need for sustainable operations with strict fiduciary responsibilities. When cash flow gets tight, it is natural to look at your organization’s endowment accounts and wonder if those funds could bridge the gap.

This article explores the complex financial maneuver of borrowing against donor-restricted and board-designated endowment funds as a potential source of capital. For nonprofit CEOs, chief financial officers, and board members, this path is navigable but requires following a roadmap in compliance with both U.S. Generally Accepted Accounting Principles (GAAP) and the Uniform Prudent Management of Institutional Funds Act (UPMIFA).

Understanding Your Endowment Net Assets

Before making any moves, you need a clear understanding of your organization’s net assets. An endowment is simply an established fund of cash, securities, or other assets intended to provide income for the maintenance of a not-for-profit entity (NFP) in perpetuity.

Endowments generally fall into two primary categories:

• Donor-Restricted Endowment Funds: These are created by a donor stipulation requiring the gift be invested in perpetuity or for a specified term. Donors or laws may also require that a portion of income or gains be added to the gift and invested under similar restrictions.
• Board-Designated Endowment Funds (Quasi-Endowments): These are created by an NFP’s governing board by internally designating a portion of net assets without donor restrictions to be invested in perpetuity or for a long period. Because these restrictions are internal, the board retains the right to expend these funds at any time.

The Cardinal Rule: Donor Intent

When managing these funds, donor intent is your “north star.” Donor restrictions are legally binding under multiple regulatory bodies, most notably UPMIFA, which outlines an NFP’s duties in managing the endowment.

Additionally, the state attorney general has the ability to oversee charitable organizations and enforce laws that govern them. This includes taking action against an NFP that does not follow donor-imposed restrictions. It is also crucial to distinguish between the corpus (the original principal gift) and the appreciation (earnings), as their usage may have different restrictions.

Can You Borrow from Your Donor-Restricted Funds?

The short answer is: It is complicated, but sometimes possible.

Borrowing from Donor-Restricted Funds This practice is highly constrained and generally discouraged. It requires a deep dive into the original donor agreements and UPMIFA guidelines. The board must demonstrate “prudence”—acting with caution, sound judgment, and diligence—and ensure the action maintains the fund’s long-term purchasing power. Violations are serious and could result in intervention by the state’s attorney general. Always consult legal counsel before even considering this path.

Borrowing from Board-Designated (Quasi) Endowments This is significantly more flexible because the restrictions are internal. The governing board has the authority to borrow from these funds. However, this decision must be a formal, documented action, commonly in the form of board minutes or a board resolution.

The Mechanics of Borrowing from Quasi-Endowments

If your board proceeds with borrowing from a quasi-endowment, you must handle it with the highest level of formality to satisfy auditors.

Formalize the Loan Treat the transaction as a formal, arm’s-length loan, with your organization acting as the lender. Simply moving cash around without documentation will result in additional scrutiny from your audit team. Key components include:

• A formal board resolution authorizing the loan.
• A written inter-fund loan agreement specifying the exact amount.
• A market-based interest rate and a realistic repayment schedule.

You can also consider including an interest provision to offset the earnings the fund would have otherwise realized in the endowment investment pool. 

Financial & Operational Implications

Borrowing creates several operational risks that leaders must weigh:

• Liquidity Strain: The endowment’s investment pool is reduced, potentially impacting long-term growth and returns for programmatic support.
• Repayment Burden: The operating budget is saddled with a new liability and interest expense, which could strain future operations.
• Fiduciary Duty: The board must act prudently, ensuring the borrowing is in the organization’s best interest and does not jeopardize the endowment’s ultimate purpose.

Going Concern: What Your Auditor Will Ask

A fundamental assumption under U.S. GAAP is that a reporting entity is a “going concern,” meaning it will continue operations for the foreseeable future. Borrowing from restricted or quasi-endowment assets can raise significant questions about this assumption.

How Borrowing Triggers a Review If an NFP borrows against the endowment to mitigate recurring operating losses, it indicates that current operations may not be sustainable. “Dipping into funds” for specific programs to cover general expenses can also lead to legal or reputational consequences, potentially causing further declines in revenue.

Management’s Responsibility Management must assess whether substantial doubt exists about the organization’s ability to continue as a going concern. If doubt exists, you must present a feasible plan to mitigate it, such as a capital campaign or expense reduction. Auditors will critically review your cash flow projections and repayment plans for reasonableness.

Required Financial Statement Disclosures Transparency is non-negotiable. Your financial statements must disclose:

• Details of the inter-fund payable/receivable.
• Terms of the loan, including amount, interest, and repayment schedule.
• Specific disclosures detailing the situation and management’s mitigation plans if the borrowing raises substantial doubt about going concern.

Conclusion: A Tool of Last Resort

Borrowing from an endowment is a financial strategy that is complex, carries significant risk, and requires rigorous governance. It ideally should be a strategic decision for a specific, one-time purpose—like a bridge loan for a capital project—rather than a solution for recurring operating deficits. It is also an ideal strategy only when the path to repayment is as clear as the immediate need for cash. 

We strongly encourage nonprofit leaders to consult with their auditors, legal counsel, and investment advisors before proceeding down this path.

Need help navigating these complex financial decisions? Contact our team today for specialized guidance tailored to your organization’s needs.