New Treasury regulations on program-related investments (PRIs) are generating renewed interest among private foundations seeking a more market-based way to further their charitable purposes. PRIs are an exception to the excise tax on jeopardizing investments, allowing private foundations to serve as venture capitalists, business incubators, and “social entrepreneurs” in furtherance of their exempt purposes.
The new regulations add 9 new examples illustrating the incredible flexibility of PRIs, but do not modify the existing rules. The examples show that private foundations can fund research and development, provide seed capital to domestic and foreign for-profit companies, use any manner of financial structure (debt, equity, or a combination of both), and count it all as “qualifying distributions” for the year.
What makes PRIs attractive?
1. Unlike grants, PRI money is supposed to come back, often with some return on investment. Loans may be repaid, stock sold.
2. PRIs generally count as a qualifying distribution for purposes of a private foundation’s annual distribution requirement – generally 5% of net assets.
3. When PRI funds do come back, the amount is added to that year’s distribution requirement. That provides another shot at making another PRI (or a grant) with the funds.
4. PRIs effectively provide a hidden 5% return. The asset purchased with the PRI, an equity stake in a company or a note receivable, for example, is not included in calculating net assets for purposes of the 5% minimum annual distribution. So, a 2% loan can be seen to provide a 7% return.
5. PRIs can be used as a “smoothing” tool for a private foundation’s grant-making program. When markets are up, annual distribution requirements increase. Grantees can quickly become reliant on the increased revenue, only to see a decrease when markets come back down. Private foundations can make PRIs with “extra” qualifying distribution dollars when the markets are up, and hope to see the funds return when markets are down. That way, private foundations can keep their grantees on a diet of steadily increasing funds, rather than one with wild fluctuations.
6. While the production of income or the appreciation of property cannot be a significant purpose of a PRI, the potential for a high rate of return is not a PRI killer.
7. Adding PRIs to a private foundation’s toolkit may be relatively simple. I tend to utilize a foundation’s existing grantmaking processes and documents to facilitate PRIs.
Among many other good things they can do, PRIs seem ideally suited to pick up where government sponsored R&D seems to have left off. For example, a company called Solaren, using existing technology, seeks to produce zero emission, 24/7, cost-competitive electricity from solar power collected in space. The solar power is converted to electricity, which is converted to radio waves, which are transmitted to a fixed location on earth and then converted back to electricity. They are looking for funds to optimize, test and validate the system with a kilowatt scale prototype – a step which so far appears to be a prerequisite to tapping commercial equity markets.
An environmentally-focused private foundation could make a PRI to bridge the gap, include the PRI as a “qualifying distribution,” exclude its Solaren stock from its 5% distribution requirement, potentially make a blockbuster return and, not least, improve global air quality and stem global warming.
Thank you for reading,
Ofer Lion, counsel with Hunton & Williams LLP, focuses his practice on tax-exempt organizations and nonprofits, including hospitals and health care organizations, universities and schools, research institutions, public charities, private foundations and private operating foundations. http://www.hunton.com/ofer_lion/.