Not-for-Profit Reserve Spending

By Glen Swanson, CPA

As the COVID-19 pandemic continues, an increasing number of nonprofits will face economic challenges which will require thoughtful consideration by management and boards. At this stage in the pandemic, many nonprofits have cut and/or delayed expenses. Likewise, many nonprofits have launched new donor drives and sought new grant funds. Unfortunately, these steps haven’t been enough for many nonprofits, forcing management teams and boards to consider utilizing reserves to maintain operations. These are certainly “rainy days” that justify spending from reserves, but are all reserves available to be spent?

As nonprofits consider spending from reserves, it’s important to evaluate if those reserves were created with board designated or donor restricted funds.

Board Designated
Board designations arise when revenues without a donor restriction are designated by a board for a purpose. These could be funds set aside by a board for any host of reasons – it’s a way for the board to show that the funds are “committed”.

In general, when a board makes a designation of funds, the board should honor that commitment. However, the designation does not create a legal obligation for the nonprofit, and the board can revoke the designation if desired.

Board designated (quasi) endowments are no different than other board designations, so these funds can be pulled out of the endowment if needed.

Donor Restricted
A donor restriction arises when the donor specifies that the gift be utilized for a specific purpose. If the gift is accepted, the nonprofit has a legal obligation to utilize the gift for the specified purpose. That obligation is generally binding and isn’t lifted because of financial hardship at the nonprofit.

If a restricted gift hasn’t been spent, nonprofits can go back to the donor and ask them to recharacterize the gift. Especially in these times, many donors will be willing to release a past gift to be utilized for general operations or for a less restrictive purpose. A simple letter from the donor stating the purpose restriction on the original gift is lifted/changed will be enough

If a nonprofit needs to utilize reserves to fund current operations, it should first look to its “rainy day fund” and then consider revoking board designations. When revoking a designation, it is advisable to put something in the minutes about the reasons why the funds have been undesignated and if the board wants the funds to be returned when the nonprofit’s financial health improves. To avoid potential legal difficulties and ruining relationships with donors, nonprofits should not utilize donor restricted funds without first asking donors.

As a last resort, nonprofits may look to donor restricted endowment funds to help with current financial challenges. The board has a legal duty to preserve endowments for the long-term benefit of the nonprofit, so boards need to tread carefully and may want to consider seeking legal advice before using these funds. Boards may be able to increase the spending rate on an endowment for a short period to help get them through the financial crisis. Or if more funds are needed, the nonprofit may be able to borrow funds from the endowment – this is a grey area in the law, so it is prudent to obtain a legal opinion before taking any action.

Nonprofits have had to carefully plan and build their reserves, and there is definite pain in having to utilize those funds today. However, there is also an equally important need to maintain services throughout this pandemic. Before spending from reserve, nonprofits should evaluate what reserves can and cannot be utilized. Feel free to reach out to the nonprofit team at MHCS if you have questions about your nonprofit’s particular circumstances.

Glen Swanson, CPA | Manager