Financial Planning

Philip Kojich: Tier 2 capital is a bridge between a nonprofit’s operating reserves and its long-term endowment. It’s typically board-designated capital set aside for known or anticipated needs within the two to seven-year time frame. It’s a longer time horizon than operating reserves and differs from the long-term endowment in that it usually has a specified purpose.

The concept comes from the banking industry, where Tier 2 capital helps institutions absorb losses and remain financially resilient. For nonprofits, it serves a similar purpose by helping organizations navigate uncertainty while preparing for future opportunities.

Philip Kojich: Following the pandemic, many nonprofits recognized the need for greater financial flexibility. A well-managed Tier 2 portfolio can provide a cushion if operating reserves are strained, demonstrate financial strength to donors and grantors, and allow organizations to act quickly when opportunities arise—all without disrupting daily operations.

Establishing a clear purpose for Tier 2 capital is the first step, because it guides investment decisions and helps communicate its value to stakeholders.

Philip Kojich: Unlike long-term endowments, Tier 2 capital is often intended for use within a shorter timeframe. As a result, organizations typically emphasize capital preservation, liquidity, and modest growth.

Many nonprofits use diversified portfolios that include lower-risk investments, such as laddered bond portfolios or U.S. Treasuries, with allocations based on their time horizon, liquidity needs, and risk tolerance.

Philip Kojich: We’re seeing nonprofits use Tier 2 capital in several ways. Some are earmarking assets for future facility improvements or deferred maintenance, technology upgrades to CRM systems or cybersecurity, or planning for program expansion. Others are setting aside resources to support multi-year strategic plans or major grant commitments. 

Regular reviews of an organization’s long-term strategic plan can also give boards and investment committees greater visibility into how assets will be used, leading to more informed long-term planning.

Philip Kojich: A healthy nonprofit capital structure is often built around three layers of capital. The first is operating reserves/liquidity, which helps support cash flow gaps. The second is Tier 2 capital, which provides flexibility for strategic initiatives and medium-term priorities. The third is long-term investment assets, such as endowments that are designed to help support the organization’s mission in perpetuity.

Often, Tier 2 capital exists implicitly inside either operating reserves or the long-term endowment. The value of formally recognizing all three is that it helps organizations size and time each tier deliberately and have a differentiated investment policy statement for each. This helps mitigate potential issues of having an operating reserve that is larger than required or having to draw from the endowment principal.

Philip Kojich: An investment advisor can help nonprofits define the purpose of their Tier 2 capital; develop an investment strategy that balances liquidity, preservation, and growth; and adjust that strategy as organizational needs evolve. The goal is to ensure that those assets will continue to support the nonprofit’s mission—today and well into the future.