What Are Program and Mission-Related Investments?
Private foundations possess nearly limitless options for charitable giving. Beyond grantmaking, they can align their investment portfolios with their philanthropic missions so that both pools of assets are working to effect positive change in the world. In other words, they can engage in impact investing, a widely popular investment strategy that aims to generate a positive social or environmental impact in addition to providing a financial return.
When we think of a private foundation supporting a charitable cause, most of us think in terms of grants–but foundations can also make loans and provide loan guarantees in support of their mission. Such loans are defined by the IRS as program-related investments (PRIs) and are an increasingly common tool among private foundations.
PRIs come out of the foundation’s grantmaking purse and as such, they qualify toward the foundation’s 5 percent minimum distribution requirement. However, while grant dollars go out the door never to return, PRI dollars are generally recovered in part or in whole, and may even earn some return for the foundation in the form of interest or appreciation.
To qualify an investment as a PRI, the foundation must satisfy three requirements laid out by the IRS:
o The primary objective of the PRI must be to significantly further the foundation’s charitable mission.
o The production of income or appreciation of property must not be a significant motivating factor.
o The investment must not attempt to influence legislation or elections; a PRI may not be used to support candidates for office or lobby elected officials.
Collectively, these requirements suggest that if the foundation were driven purely by financial considerations, it wouldn’t make the PRI because the loan or investment will usually have some downside that makes it unattractive to commercial investors: High risk, low return, and illiquidity are common traits among PRIs, so much that one might even consider PRIs “bad investments for a good cause.” Evidently, the IRS concurs: Because PRIs fulfill a foundation’s charitable purpose, they are exempt from the normal rules that prohibit the foundation from making so-called “jeopardizing” investments.
Foundations use PRIs creatively in myriad ways. Most first experiment with them in the form of a loan to an organization they already know well, oftentimes a prior grantee. For example, they may offer their community church a very low-interest loan to finance the construction of a new facility. Or they may provide a no-interest line of credit to their favorite art museum to help smooth out the bumpy financial times between blockbuster shows. They even may co-sign a loan to allow a housing agency to access funding from a commercial bank, which, absent a default, doesn’t require them to put a dime out the door.
Traditionally, philanthropists give away money and investors make money. The former wants to create change and the latter wants to pocket it. You’d think that the two goals would be incompatible, but a new hybrid of philanthropy and private equity investing blurs the lines, allowing foundations to do well by doing good. Similar to private equity investing, foundation donors make investments in private companies or venture capital funds—the difference being that these investments go beyond mere financial returns to provide social and economic benefits. Foundations that engage in mission-related investing (MRI) use their endowment funds to invest in profit-seeking solutions aligned with their mission. These often are social, environmental and economic challenges that cannot be easily met through grants alone.
The determination as to whether these “social venture” investments are PRIs or MRIs depends on whether they exist primarily to return a financial profit or to accomplish a social good. Let’s take two examples for a foundation fighting childhood asthma:
In our first example, the foundation becomes aware of a promising drug that’s in development. It’s only effective against a rare type of childhood asthma, so it doesn’t have much commercial potential and is therefore unlikely to make it into production. The foundation could provide a seed money loan for the drug’s development and this “poor investment for a good cause” would qualify as a PRI and count toward its 5 percent minimum distribution requirement.
In our second example, the foundation becomes aware of a terrific new company that’s developing an inexpensive, electric car capable of going 500 miles before recharging. This is a very exciting investment opportunity for a whole host of reasons. From a financial standpoint, an extended-range, inexpensive, electric car has tremendous market appeal; from a mission standpoint, it’s also attractive because car emissions contribute to childhood asthma. Clearly, investing in this start-up would be compatible with the foundation’s fiscal goals and mission objectives. However, because the venture foremost is considered a good investment from a financial standpoint, it qualifies as an MRI and not a PRI.
Keep in mind that MRIs, unlike PRIs, are subject to jeopardizing investment rules and that a private foundation can be subject to excise taxes for making imprudent investments. For this reason, involvement in any of the activities outlined here and below should be based on a well-considered investment policy that includes a thoughtful asset allocation strategy among different classes of risk.
Three Main Approaches to Mission-Related Investments
Mission-related investments (MRIs) may be made in a variety of ways. For instance, you can buy stock in a well-established company that’s aligned with your mission, you can invest in a social investment fund, and you can conduct angel investing in start-up companies that have a social mission.
1. Buying Stock in Well-Established Companies
An obvious investment choice for a foundation dedicated to environmental conservation might be a tech giant that’s developing more affordable solar panels. But what about a granola manufacturer that buys Brazil nuts, which only grow in healthy rainforests, at above-market rates in order to incentivize forest preservation?
2. Social Investment Funds
A foundation willing to take some risk with a portion of its investment capital can become an investor in one of the tiny but growing crop of “social investment funds.” Traditional venture funds raise capital from private investors and select a portfolio of young companies in which to invest. They provide not only funding to the young company, but also expertise and connections, all in exchange for an ownership stake and often, a seat on the board of directors.
Social investment funds take this same approach but focus on finding and funding potentially profitable businesses with a social mission. Managed by professionals who charge a service for their fees, these funds seek target companies, known as “social enterprises,” that focus on providing positive social impact as well as financial returns. Examples might include technologies that provide clean water, facilitate remote access to health care, or improve public safety. And social venture funds aren’t limited to technology start-ups. They can support fair trade suppliers, companies that provide healthy, organic school lunches, car-sharing services, and much more.
Social investment funds are often dedicated to a specific issue. For example, Good Capital’s Social Enterprise Expansion Fund (SEEF) provides growth capital to social enterprises that address the root causes of inequity in the U.S. and around the world. Another fund, Root Capital, aims to grow rural prosperity in poor, environmentally vulnerable places in Africa and Latin America.
Because the concept of social venture investing is still in a nascent stage of development, these funds often lack traditional track records and transparency. New tools have been developed to help social investors track and evaluate the social impact of their investments, such as the Global Impact Investment Ratings System (GIIRS, pronounced “gears”). Some funds (and some funders) are rigorous in defining and measuring the social impact of their portfolio companies while others seem to be satisfied with the idea that they are “supporting good work.”
3. Angel Investing
“Angel investors” are “first-in” funders who personally evaluate individual investment opportunities and use their own funds to invest directly. Where social investment funds rely on the expertise of a professional management team, angel investing might be considered the “do-it-yourself” approach to social investing.
Angel investors typically take on very high risk in early-stage companies in the hopes of a commensurately high reward if one of their companies turns out to be the next Google. For private foundations and individual philanthropists who are willing to put in the time and effort themselves to grow social enterprises, an angel approach to social investing can be attractive because it allows them to use not only their money but also their networks and expertise to help a young social enterprise get up and running.
In some cases, angels band together to form networks or loose affiliations that share the work of doing due diligence on potential investments. Each member then decides if he or she wants to take part in the investment. A well-known social angel network, Investors Circle, is an environmentally focused, international group of angel investors founded in the early 90s. Today, there are many such networks including Toniic, an international group of social investment angels founded by KL Felicitas Foundation donors Charly and Lisa Kleisner. There are also communities of angels that come together on “Investor Days” around the country to hear pitches for start-up social enterprises, sponsored by entities such as the Unreasonable Group in Colorado and Impact Engine in Chicago.
For the foundation that looks closely at its current investment portfolio and finds a lack of alignment with its grantmaking objectives, there are many options to put both pools of assets to work for positive social outcomes. From relatively low-risk cash management options with community development financial institutions to high-risk angel investing in social enterprises, every philanthropist can become an impact investor. The key to success is to take an incremental approach, starting with a small portion of assets at first and then expanding as you gain experience and confidence.
Jeffrey Haskell, J.D., LL.M. is chief legal officer for Foundation Source, which provides comprehensive support services for private foundations. The firm works in partnership with financial and legal advisors as well as directly with individuals and families.
Read part one of this series here.