Nonprofits – Restricted vs. Unrestricted Funds

Nonprofits – Restricted vs. Unrestricted Funds

The Average Joe may believe that the way donations to nonprofits work is that a check is written to the nonprofit who then turns around and spends the money however the nonprofit sees fit. That’s actually not entirely true. When money is donated to a nonprofit, the funds are categorized as unrestricted, temporarily restricted, or permanently restricted. The only way a donation can carry a temporarily or permanently restricted title is if the donor imposes one at the time the money is donated. The below offers a quick description of each of these types of funds:

  • Unrestricted Funds – Funds which do not contain donor-imposed restrictions and are available for general operational use by the nonprofit organization;
  • Temporarily Restricted Funds – Funds which contain a temporary donor-imposed restriction for either a particular period of time or for a particular purpose.  The restriction on these types of funds expires after the passage of that period of time or the fulfillment of that particular purpose;
  • Permanently Restricted Funds – Funds for which the corpus of the fund has to be maintained in perpetuity, with their purpose fulfilled using earnings from interest or investments.

If a nonprofit depends on all three donation types to fulfill the organization’s mission, what happens when it runs out of unrestricted funds used for day-to-day operational needs but has a large stash of restricted funds at hand? Some organizations choose to borrow against their restricted funds to pay the immediate expenses required to keep them in business.

The problem against borrowing restricted funds is the potential for the nonprofit to be out of compliance – it is a legal obligation for nonprofits to use restricted funds in the way they were designated to be used by the donor. If restricted funds are misused, donors could potentially ask for their money back or even seek legal action against the nonprofit.

One manner applied by nonprofit organizations to mitigate the unrestricted fund/cash flow problem is to have disclaimers when fundraising, clearly stating that the nonprofit can move or use money as it sees fit. For example, The Wikimedia Foundation, the nonprofit organization that manages and runs the popular website Wikipedia, fundraises so that they do not have to sell ad space on their websites. On their fundraising page, Wikimedia states that the donation from that specific solicitation goes to technology, people, and projects in general.  Donations that come from a specific fundraiser or appeal are called “solicited funds” and must be used for that specific purpose; in Wikimedia’s case, they’ve generalized the solicitation to be used for a wide-range of the nonprofit’s efforts.

Transparent accounting and careful budgeting of restricted funds are vital for nonprofits to continue to be successful in obtaining grants, donations, and fostering trust within their supporting community. For more information on nonprofit creation, restricted fund compliance assistance, or nonprofit corporate law in general, contact Rosana Herera-Ortega, San Diego corporate attorney, for a consultation today.