From Stanford Social Innovation Review. By Stacey Faella & Margaret Gifford Nov. 2, 2017.
Impact investing, or the idea of making money and doing good, is going mainstream and investors of all types are jumping into the marketplace—including foundations. But while some of the largest foundations have led the charge on impact investing, the movement is leaving many behind.
Earlier this year, the Ford Foundation committed one billion dollars from its endowment to mission-related investments, opening up a substantial line of potential investment for impact-driven enterprises. Despite the media coverage of this big move, the reality is that the vast majority of US foundations are not yet actively making impact investments. Adding to misperceptions around impact investing for foundations is that people less familiar with the terms describing these activities—SRI, MRI, and PRI—sometimes use them interchangeably. But these terms have meaningful differences that speak to just how much impact the investor seeks to generate, as well as legal distinctions around the use of these tools. While all forms of impact investing can be used to increase a foundation’s impact, we believe program-related investments (PRIs) are a particularly underutilized tool for small and mid-sized family foundations.
Defining the Field
Let’s start by unpacking the common impact investing terms:
Socially responsible investments (SRIs) are investments that are expected to do no harm. At a minimum, they have been screened to avoid investing in companies that are causing negative impacts to our environment or to society.
Mission-related investments (MRIs) are investments made with the goal of having a positive impact on our environment and/or society while also generating a financial return. MRIs are typically made out of a foundation’s endowment and are subject to IRS rules on non-jeopardizing investing.
PRIs must have charitable intent as their primary purpose, with financial returns as a secondary goal. PRIs are the only ones that have a clear definition from the IRS and the only one that enables private foundations to make investments outside the typical rules regarding prudent investing. PRIs fall between grants and traditional investments, and reflect qualities of both. In fact, they can take many forms (including equity, debt, or guarantees). But unlike traditional investments, advancing the foundation’s mission must be their foremost purpose, and to drive impact, they often are made on concessionary terms that are not aligned with the level of risk the investor is taking on.
PRIs at Small and Mid-Size Family Foundations
According to data from The Foundation Center, more than 98 percent of all foundations have assets less than $100 million. These foundations accounted for more than 50 percent of all grants made in the United States in 2014. Yet this influential group has lagged in adopting impact investing practices due to real and perceived barriers to entry. Research from the Foundation Center’s GrantSpace found that of the thousands of grantmaking foundations in the United States, just a few hundred made PRIs in 2016—only about one in three.
Given the benefits of PRIs as a unique tool for advancing impact and that larger foundations have demonstrated their use, why do so few family foundations use them?
Culture and capacity are the two primary barriers. In terms of culture, trustees and staff must first understand what a PRI is and how the foundation can use it to advance its mission. Then they must address questions such as: What would be the relationship between PRIs and grants? What would be the impact of thinking more like an investor and less like a donor at times? How would the decision to make PRIs change the foundation’s decision-making and organizational structure?
Once a foundation answers these culture questions, it needs to consider capacity and determine whether program staff has the expertise to source and vet investment opportunities. It will also need to consider how to communicate its interest in making PRIs to social entrepreneurs in order to increase “deal flow,” or the flow of investable projects that fit the mission. Entrepreneurs often ask our team at Watervine Impact for help finding PRIs so that the social mission of their company can remain intact as it raises capital. Furthermore, the ability to conduct due diligence and structure an investment vehicle that’s right for both the investor and entrepreneur is critical, and foundations often must build the capacity to do that work—either by developing skills internally or by outsourcing to consultants or other experts.
Early Adopter: Woodcock Foundation
The Woodcock Foundation is one example of a medium-size family foundation that has begun to make program-related investing part of its mission. Several years ago, the foundation began to look at PRIs as a complement to its grantmaking. It wanted to be able to support both nonprofit and for-profit enterprises advancing new business models, including during the proof-of-concept phase so that entrepreneurs could attract follow-on capital. The foundation was also interested in PRIs as a way to create impact in the present while being able to recycle capital for future impact, as that capital is returned and reinvested in new grants or PRIs.
Before The Woodcock Foundation made its first PRI in 2008, its financial and legal advisors had to get comfortable with PRIs, and the board and staff alike had to understand what PRIs were and how best to use them. The team also had to figure out a process. Who identifies opportunities? Who conducts due diligence? Who approves the PRI in concept, and who approves the contract? The foundation had to build its internal capacity at the board and staff levels to take full advantage of PRIs.
Lumni, an innovative enterprise supported with PRIs by the Woodcock Foundation, helped student Luis Fernando Sanchez realize his dream of becoming a doctor through its career development program. (Photo courtesy of Credit Sixup)
At The Woodcock Foundation, PRI sourcing comes from all directions. Trustees who come across opportunities bring them to the table. Financial advisors pass ideas to foundation staff when they’re not a good fit for a mission-related investment. And staff source ideas based on trustee interests and priorities. Over time, the team has made the PRI consideration process consistent and clear by establishing procedures for involving various parties in decision-making and by adopting a standardized due diligence template. As organizations refine their process, they will face questions that don’t have right or wrong answers; rather, the answers will depend on the interests and intent of the individual foundation. If a foundation is willing to make numerous PRIs, it can test various strategies to balance risk with financial and impact returns, which has been The Woodcock Foundation’s approach so far.
Why PRIs Can Work for Small and Mid-Size Family Foundations
By definition, PRIs are impact-oriented.
PRIs offer efficiency and an opportunity for achieving greater impact through recycling capital.
PRIs can be used to fulfill the 5 percent payout requirement at a foundation, unlike other types of investments. Many foundations use PRIs to go beyond the 5 percent requirement too.
PRIs open the door for foundations to support innovative social entrepreneurs and new market categories.
PRIs spark market growth. They can catalyze the flow of additional capital into the social sector by proving new business models and de-risking investments for the capital markets.
PRIs are unique and valuable, mission-driven financial tools that small and mid-size foundations can use alongside their grantmaking to support social entrepreneurs, prove new business models, catalyze additional investment, and recycle donor dollars to achieve greater impact.