carousel | April 23, 2016

IRS Widens the Scope of Program-Related Impact Investing by Foundations

ImpactAlpha
The team at

ImpactAlpha

Federal guidelines are finally catching up to the kind of impact investments leading philanthropic foundations have already been making in for-profit companies and other market-based approaches to social and environmental problems.

fullstack

The new IRS and Treasury Department guidance on so-called “program-related investments” by foundations, to be published Monday, are the latest in a series of policy signals that the Obama Administration is keen to expand impact investing as another tool for tackling such challenges.

“With increased comfort about using a variety of prudent financial tools, private foundations can continue to help create safe communities, strengthen schools, and achieve other charitable goals that make our country a place where everyone has the opportunity to succeed,” wrote David Wilkinson, the director of the White House Office of Social Innovation and Civic Participation on the White House blog.

The White House announcement should reduce legal uncertainties around foundations’ ability to use equity, loans and guarantees from their program budgets to advance their missions. The regulations provide nine new examples of the kind of investments that qualify as PRIs, including disease research, the environment, smallholder agriculture and other areas.

“Today’s guidance reassures foundations that a wide range of investments can qualify as PRIs and reduces the perceived need for legal counsel or IRS rulings in many cases,” Wilkinson added.

PRIs investments, like grants, can count against foundations’ minimum annual payout requirements, so their expanded use could conceivably reduce the amount of funding available to nonprofit organizations, which traditionally have been the main recipients of foundation funding. But because PRI capital, unlike a grant, is expected to be returned, such funding can be recycled many times over. That could expand total funding and preserve traditional grants for areas, such as policy and advocacy, in which repayment is not feasible.

Currently, less than 1 percent of foundations actually make PRIs. Even among practitioners, only 0.5 percent of program budgets is committed to such investments.

The new PRI regulations follow favorable guidance last fall from the IRS on mission-related investments, or MRIs, a separate category of impact investments foundations can make from their endowment assets. Together, the actions represent a recent push by the Obama Administration to catalyze the use of impact investing at private foundations to address complex problems facing regions, communities and schools.

Limited Guidance
The latest move reflects longstanding efforts by the Council on Foundations and a more recent push from the National Advisory Board on Impact Investing to clarify and expand the definition of PRIs. Guidance to date on the use of PRIs has been limited to 10 original examples that date back to when PRIs were formalized in the tax code in 1969.

Philanthropic leaders and PRI proponents originally proposed the new PRI examples back in 2012. The White House says the finalized examples received only minor clarifications after “overwhelmingly positive” public comments.

The legal complexities didn’t stop many of the larger foundations, which have pushed forward with the use of PRIs, often testing the bounds of the IRS’ original use cases. The MacArthur Foundation has deployed more than $500 million in PRIs. The Packard Foundation has made more than $750 million in PRIs and the Gates Foundation has deployed $1 billion. The Ford Foundation, which pioneered the practice in the 1960s, has made more than $550 million in program-related investments and currently has an allocation of $280 million to such investments.

Without a broader and more detailed definition many foundations have simply avoided the risk of making a PRI that may be judged by the IRS to fall outside the examples. Smaller foundations often lack the legal and financial expertise to even gain an IRS ruling. Foundations interested in making climate-related investments, for example, for which PRIs could help can unlock capital for innovation, found little support in the original guidance.

New Bounds
The new examples largely reflect the kinds of investments pioneering foundations have already been making. One example covers equity investments in companies that develop new drugs and vaccines for diseases that primarily affect the poor; The Gates Foundation has investments in biotech companies seeking vaccines and drugs for malaria, tuberculosis and other neglected diseases.

Also included in the new examples are equity investments in businesses contributing to reductions in environmental deterioration and below market rate loans to businesses affected by natural disasters. The Packard Foundation has been a leader in conservation finance, making a low-interest PRI loan, for example, to attract commercial investors to Ecotrust Forest Management’s second fund.

Also included are below-market-rate loans to small businesses in developing countries and below-market-rate loans to companies that purchase coffee from poor farmers, in which proceeds from the loans will be used for training. A specific example even provides clarity around the the use of loan guarantees in which foundations reduce risks in order to draw in private investment capital to achieve a charitable mission.

[seperator style=”style1"]Disclosure[/seperator]

ImpactAlpha has received financial support from the Gates, MacArthur and Packard foundations, among others.

Photo credit: U.S. Navy photo/Released