09 Program-Related Investments, United States
Program-Related Investments, United States
Grow and Direct Private Capital
Geography: United States
Toolkit step: Grow and Direct Private Capital
In Brief: In the United States, Program-Related Investment (PRI) is a category of philanthropic investment, designated by the US Internal Revenue Service, that allows foundations to make concessionary (below-market rate) investments and count them towards their annually mandated philanthropic giving, provided that the investments meet specific requirements. PRIs allow foundations the flexibility to make patient, low-cost and/or higher-risk investments in support of their mission. However, policy-makers must take into consideration several challenges in implementing PRIs.
PRIs provide several insights for policy-makers looking to the US as an example of how to grow and direct private capital to social enterprise and innovation, including:
- Identify the philanthropic or other potential investors that would benefit from preferential treatment for concessionary investments
- Determine whether there is sufficient demand for concessionary investments to merit the development and dissemination of a new type of investing practice
- Consider complementary policy interventions that can leverage and expand the limited capital catalysed through a PRI-type programme
Policy Goals and Development
In the United States, foundations historically have played a critical role providing no-cost capital in the form of grants to underserved communities. According to US tax law, foundations are tax-exempt organizations that must distribute at least 5% of their total assets each year to maintain their tax-exempt status. Such distributions are dispensed primarily through grant-making. During the 1960s, several large foundations became interested in making patient, low-cost and/or higher-risk investments in support of their mission, investments that were challenging to justify under existing tax and investment law. In 1969, at the urging of these foundations, the federal taxing authority – the US Internal Revenue Service – created a new category of investment for foundations, Program-Related Investments (PRIs).
This new investment category allowed foundations to count PRIs towards their annual 5% distribution mandate, giving them the flexibility to make investments in support of their mission. PRIs also have a multiplier effect; unlike grants, they aim to return the principal amount of the investment back to the foundation and, once returned, dollars used for PRIs must be recycled into other charitable purposes, whether reinvested as a PRI or awarded as a grant.
PRIs offer several potential advantages as a philanthropic tool. For instance:
- By taking on risk, or providing concessionary capital, PRIs can be used to leverage private-sector investment and bring social interventions to scale.
- Longer-term or higher-risk capital can help direct market activity towards areas where, due to market failures or social conditions, the market would otherwise be inactive.
- The rigour of underwriting and servicing PRIs can build capacity in the end users of capital, transforming innovative practices into durable institutional structures. For social enterprises particularly, PRIs can support investees as they scale and grow to a size where they can attract more traditional capital.
The repayment of PRIs allows foundations to leverage their resources more effectively. Early PRI adopters provided low-interest loans to build affordable housing or support small-business development in low-income communities. Over time, PRIs have grown to play an important role in the larger US community development field. They have also been used in support of environmental goals, such as land preservation, energy efficiency programmes and alternative energy production. More recently, supported by additional guidance from the IRS, PRIs have been used to fund social enterprises and other emerging social innovations.
Policy in Action
PRIs can come in a variety of forms, including loan guarantees, subordinated debt, senior debt and equity investments. They may be made as investments in non-profit or for-profit entities, or directly to individuals. Their unifying characteristic is that they are made for an explicitly social purpose, on terms that private-market actors may not normally accept.
The Internal Revenue Service applies three tests to confirm that a PRI qualifies as part of a foundation’s 5% distribution mandate:
- The primary purpose of the investment is to accomplish a charitable purpose as defined by the US tax code.
- The financial return of the investment is the mechanism to create social benefit, not the goal in itself.
- The investment is not associated with political lobbying.
Shortly after PRIs were established, the IRS published a set of examples meant to give guidance on the sorts of investments that meet these tests. An update in 2012 added nine new examples for guidance, reflecting changes in foundation practice and highlighting issues such as the acceptable risk-adjusted rates of return for PRIs, their applicability to non-US investees and the range of charitable considerations (beyond disadvantaged communities) that were acceptable for PRIs, including environmental considerations and the advancement of science and the arts.1
While the updated list of examples helps clarify the range of potential PRIs, the burden is still on foundations themselves to ensure that any given PRI meets IRS requirements.
Impact to Date
PRIs have been an established form of philanthropic investment for decades and have grown significantly over time. The Foundation Center, a research organization that studies philanthropic activity, has reported that the cumulative dollar value of PRIs between the period of 1990 and 2009 was US$ 3.7 billion and, further, that the use of PRIs is increasing. For example, the number of foundations that reported having made a PRI in 1998 was 122 versus 172 in 2007. Similarly, the number of unique PRIs distributed in 1998-1999 was 581 versus 705 in 2006-2007. Cumulative PRI investments to date likely total well over US$ 4 billion. As previously mentioned, the range of areas in which PRI investments are applied has also expanded.
In addition to their immediate impact, PRIs have also helped support the development of a broad array of investment intermediaries, for example community banks or loan funds, that blend public, private and philanthropic capital, especially in the field of US community investment. PRIs have helped these institutions build investment track records and infrastructure. For an example of this practice, see the “PRIs on the Ground” box in this section.
However, PRIs are not yet central to US philanthropic practice. Only a small percentage of foundations use them, and few use them to a significant extent. A variety of reasons explain the low levels of implementation. PRIs remain relatively unknown and, where known, are somewhat daunting to foundations. For example, the investment underwriting process can be challenging and unfamiliar, requiring expertise in business management, lending or financing, which foundation staff may not have. Smaller foundations may not feel that they have the internal capacity to manage PRIs. Further, depending on the level of complexity, PRI execution may require greater expenditures, such as for legal review to ensure that the PRI in question fits within the IRS definition, and longer-term monitoring and oversight than most grants.
Policy Recommendations for Scaling Social Innovation
In sum, PRI legislation in the US has helped create a network of investors and investment intermediaries with specialized skills in serving underserved populations. Relatively limited PRI usage in the foundation community suggests that there are real transaction costs, but the long-term efficacy of programmes across a number of foundations indicates that PRIs have helped provide an important and unusual source of low-cost and/or risk-bearing capital that the market would not otherwise have. Policy-makers interested in adopting PRIs in other countries should consider several lessons from the US experience:
Identify the philanthropic or other potential investors that would benefit from preferential treatment for concessionary investments
This policy is moot in places without a relatively vibrant philanthropic community. Policy-makers should make sure, however, that foundations exist in such a number and are open enough to the potential of PRIs that this policy will be used and useful.
Determine whether there is sufficient demand for concessionary investments to merit the development and dissemination of a new type of investing practice
In the United States, the philanthropic sector devoted resources to create investable opportunities and generate demand for investment. Without these additional philanthropic efforts that helped to foster social enterprise, the opportunities for PRIs would be much more limited.
Consider complementary policy interventions that can leverage and expand the limited capital catalysed through a PRI-type programme
PRIs have been particularly effective in combination with other policies – including the US Government’s Community Development Financial Institution (CDFI) Fund and tax expenditures such as the Low Income Housing or New Markets tax credits, both of which offer incentives for private-capital participation in the development of affordable housing and investment in underserved communities. Additional policies can help foundations use their concessionary capital to continue to leverage private-sector dollars more effectively.
PRIs On the Ground
The Kresge Foundation
One key issue that has attracted the attention of US foundations is the lack of access to primary healthcare in poor communities. In tackling this problem, the Kresge Foundation, in conjunction with the Local Initiatives Support Corporation (LISC) and Morgan Stanley, recently built an impact investing fund that will aggregate US$ 100 million in capital to build community health centres and affordable housing with integrated health treatment.
The Kresge Foundation was able to use US$ 6 million of PRI investment to mitigate the risk for conventional investors, leveraging institutional capital from private markets. At the same time, the fund benefits from several complementary public policies, including new opportunities created by federal health legislation – the Affordable Care Act passed in 2010.