Program – Related Investments Key Tool for Impact Investors

Increasingly, charitable donors are interested in “impact investing” with their philanthropically committed capital. They seek more creative ways to align their investments with their missions.

Earlier this year, in “All investing is impact investing,” I discussed the growing recognition that grants and investments can generate both financial returns and social impact. In this column, I expand on this popular topic.

In the Tax Reform Act of 1969, the Internal Revenue Code permitted a giving vehicle for foundations called Program-Related Investments, or PRIs. A PRI is a method of making capital available to both nonprofits and for-profits that are addressing social or environmental concerns.

PRIs can be part of an integrated strategy, along with grants, to achieve the mission. PRIs differ from grants in an important way. A grant is a “social investment” that produces a negative financial return to the donor. With a PRI, a foundation lends money to, or invests in, a nonprofit or for-profit in a way that furthers the mission and actually provides a financial return to the foundation.

Although PRIs are still relatively uncommon, the Ford Foundation and others have been using them successfully for years.

Detailed proposed regulations that clarify and expand the definition of PRIs were issued in 2012 and should be finalized later this year.

In order to qualify as a PRI, three key criteria must be met:

1. The investment’s primary purpose must be to advance the foundation’s charitable objectives;
2. Neither the production of income nor appreciation of property can be a significant purpose; and
3. The funds cannot be used directly or indirectly to lobby for political purposes

Examples of PRIs include:

• Making a low-interest-rate loan to a nonprofit to pay off a building mortgage, saving the nonprofit significant interest over the life of the loan;
• Making an equity investment in a fund or loan to a nonprofit that enables it to accelerate the purchase and delivery of essential goods and services. An example of this use is the UNICEF Bridge Fund;
• Making an investment in a company researching and developing an “orphan drug” to help cure a disease that primarily affects people in developing countries;
• Investing in or lending money to a nonprofit or for-profit in a developing country that creates a recycling program to prevent pollution;
• Lending or guaranteeing funds to build a nonprofit child-care facility in a low-income neighborhood;
• Lending money to or investing in small businesses that employ people after a natural disaster or in a low-income area where commercial funds are not readily available;
• Investing in a Community Investment Note, like Calvert Foundation’s Ours to Own (ourstoown.org), where funds are invested in community development efforts and a return on the investment is generated; and
• Providing low-interest or no-interest loans to low-income students.

If the PRI meets IRS criteria, the benefits to a foundation and the community can be significant. Such investments:

• Make loans or capital available to socially beneficial organizations at rates that are often commercially unavailable to the nonprofit or for-profit recipient;
• In a loan scenario, return both the principal and the interest to a foundation – which enhances a foundation’s impact by enabling its assets to grow and be recycled into further grants and PRIs;
• In an investment scenario, allow for potential capital appreciation and return for future use;
• Qualify as part of a foundation’s annual required 5 percent payout; and
• Can be funded from a foundation’s endowment assets or its grant-making budget, or both.

Although the tax law specifically refers to private foundations, a growing number of community foundations or institutions like the American Endowment Foundation are encouraging the use of PRIs with donor-advised funds.

To learn more, see Mission Investors’ Guide to PRIs, Impact Assets, Impact Assets 50, and the Impact Finance Center.

Before establishing a PRI, it is important to seek tax or legal advice to make sure that your setup complies with the law and that “expenditure responsibility” requirements are satisfied.

PRIs help nonprofits solve social problems by using market-based tools, and enable donors to have greater impact by growing and recycling at least a portion of their philanthropic assets for future use.

This post originally appeared in the Denver Post on April 12, 2015. It is re-posted here by the author with permission.