Master Your Foundation’s Mission-Related Investment Options: Part 2

This is the second installment in a series of articles on how you can put mission-related investing (MRI) trends to work for your private foundation and its philanthropic goals. Read Part 1 for an introduction to various types of mission-related investments.

Your foundation has probably run into this problem before: you have a vast number of causes to support but limited resources to spend. You already give targeted grants that further your mission. How can you maximize your impact? How can you stretch your charitable dollar further?

Program-related investment (PRI) is an IRS term that refers to an investment made by a foundation that relates to the foundation’s exempt purposes and therefore isn’t taxable as unrelated business income. These investments can also count toward the 5 percent payout that foundations are required to make each year, and they provide benefits that grants cannot. Since you’re making an investment, you should make money on it. Eventually, you get your money back and can then reinvest the funds. Furthermore, PRIs provide anchor funding, convincing governments, banks, and for-profit entities to invest alongside your foundation. Additionally, PRIs are typically long-term investments that deliver support to the communities that need it the most.

PRI in Action

What could a PRI look like for your foundation? PRIs are typically loans or capital investments made by a private foundation to further its charitable purposes at a low or zero-percent interest rate. PRIs come in many shapes and sizes, such as:

  • Low-interest or interest-free loans to needy students
  • High-risk investments in not-for-profit, low-income housing projects
  • Low-interest loans to small businesses owned by members of economically disadvantaged groups for whom commercial funds at reasonable interest rates aren’t readily available
  • Investments in businesses in deteriorated urban areas under a plan to improve the economy of the area by providing employment or training for unemployed residents

For example, if your foundation’s purpose is to alleviate hunger, you may currently give grants to organizations that buy food for the needy or build structures to facilitate the distribution of food. If you use a PRI as an alternative, you can provide a below-market loan to a company to train poor farmers in advanced agricultural methods. The money eventually returned on the loan can then be used for a different investment or further training. Your PRI counts toward your 5 percent required charitable distribution and helps a cause you may not have otherwise been able to support, for example, because the organization isn’t a qualifying public charity.

IRS Requirements

The IRS gives specific details as to what constitutes a PRI:

  • The primary purpose is to accomplish one or more of the foundation's exempt purposes.
  • The production of income or appreciation of property isn’t a significant purpose.
  • Influencing legislation or taking part in political campaigns on behalf of candidates isn’t a purpose.

When considering whether the production of income or appreciation is a significant purpose, it helps to ask the question: “Is this an investment that someone interested strictly in income or appreciation would invest in?” If so, then it may not constitute a PRI. To fit the bill, an investment must be related to the foundation’s exempt activities and be an investment that wouldn’t have been made otherwise. The IRS considers whether a traditional investor would make the investment on the same terms. Note that depending on a foundation’s exempt purpose, what qualifies as a PRI for one foundation may not qualify for another.

Accounting for PRIs

When accounting for a PRI, your foundation needs to take into account that a PRI is truly considered an investment, not simply a charitable distribution. It needs to be reflected on your balance sheet accordingly. When income is received, it’s typically considered investment income, which means it’s subject to the 2 percent excise tax on net investment income. If your private foundation meets certain distribution requirements, the tax can be reduced to 1 percent.

Another benefit of a PRI is that it counts toward your foundation’s 5 percent charitable distribution requirement in the year in which it’s disbursed. Then, as principal is repaid, the repayments count as a negative distribution. For example, a $500,000 repayment must be redistributed as grants or new investments in the year it’s repaid.

You’ll also want to consider each individual PRI in the context of your foundation’s overall investment allocation. Is it a loan that would be considered part of your fixed-income allocation? Do you need to offset the PRI or hedge against it elsewhere? Because PRIs are both below-market-rate investments and charitable distributions, you should have a separate investment policy statement (IPS) covering them. While this may seem like a hassle in the short term, the IPS can spell out types of acceptable PRIs, set expectations for social and environmental returns, and put guidelines in place that will be useful in analyzing when to discontinue a PRI or when to invest in a new opportunity.

Next Steps

If a PRI sounds like an option for your foundation, make sure your board is aware of other options—such as grants, mission-related investments (which we’ll cover in our next installment), and other funding vehicles. The board decision should be documented in the meeting minutes.

Also keep in mind if your foundation decides a PRI is an appropriate investment vehicle, there’s an expenditure responsibility requirement, meaning you need to obtain a written and signed agreement from the intended recipient before you invest the funds.

Want to learn more about PRIs? Contact your Moss Adams not-for-profit professional for further information.