Recently, the Obama Administration took a simple but important step that has the potential to do a lot of good in communities across the country – anything from improving education, creating opportunity in low-income communities, or keeping our water and air safe.
Traditionally, foundations have tackled our most vexing problems primarily by making grants to organizations. Foundations are required to make annual charitable contributions of at least five percent of their total assets. These overwhelmingly are done via grants and most stay very close to the five percent minimum. The remaining 95 percent of assets are maintained in an endowment and typically invested in a diversified portfolio in order to preserve or increase value to enable continued giving in the future. The proposed rule issued by the Treasury Department and IRS would make it easier for philanthropies to make what are called Program Related Investments (PRIs).
PRIs allow foundations to put more of their resources to work to advance their charitable mission through means other than grant-making – like equity investments, loans, loan guarantees, or other investments. Despite their flexibility, PRIs historically have not been used with much frequency because of confusion as to how they work and the high costs associated with them. For example, many foundations find it necessary to proactively seek legal counsel to confirm that an investment would qualify under the definition of charitable purpose even before using a PRI.
To address these concerns, the Treasury Department and the IRS proposed a rule that includes updated examples of how private foundations may use PRIs to fund charitable activities, which will help foundations make these investments more easily and at a lower cost. The guidelines illustrate that organizations can use PRIs to support groups working on a diverse set of issues from preserving the environment, to furthering education and scientific research, to relieving the poor and distressed.
This important update is the first in 40 years since PRIs were implemented in 1972.
The proposed rule also clarifies how foundations can use different methods such as credit enhancement arrangements to strengthen the capacity of organizations. This approach can leverage the balance sheets of foundations, enabling “capital activation” and potentially adding significantly to their capacity to drive social impact. Such methods can serve as an indicator to other institutional investors about the possibilities of deploying capital in creative ways to generate value and strengthen communities.
A PRI is an investment made by a foundation, which, although it may generate income, is made primarily to accomplish charitable purposes. PRIs are novel for several reasons. First, they provide foundations with the flexibility to fund activities serving charitable purposes in a variety of ways beyond conventional grants. Second, such investments can be made to tax-exempt charities but also to social enterprises and conventional businesses. And third, unlike conventional grants, PRIs can take various forms, including equity investments and low-interest loans.
These guidelines do not cover all the potential scenarios, and public comments on the proposed rule have been requested by July 18. We hope that the proposed rule will spark a dialogue over the next two months with the philanthropic community. Through feedback on the guidelines and an exchange of ideas, we hope to update the regulations in a manner that serves the public interest. This additional guidance is expected to facilitate the ability of foundations to determine whether investment qualifies as a PRI, reducing the transaction costs, conserving a foundation’s resources for additional charitable activity, and increasing capital flows for charities and social enterprises that can create jobs and generate impact.
To comment on the proposed rule for PRIs, please visit the Federal Register.
Jonathan Greenblatt is Director of the Office of Social Innovation and Civic Participation.