March/April 2001

Fundraising

Program-Related Investments

More complicated than grants, but worth considering



By Robert Jaquay


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The term “program-related investment” (PRI) was first coined in the Tax Reform Act of 1969. As currently defined in the tax code, a PRI is any investment by a foundation that meets three tests: 1) its primary purpose is to further the tax exempt purposes of the foundation; 2) the production of income or property is not a significant purpose (meaning that a prudent investor seeking a market return would not enter into the transaction); and 3) it is not used to lobby or support lobbying. Unlike a grant, PRIs are expected to be repaid.

As encouragement for foundations to use their assets for philanthropic purpose, the tax code counts the entire amount of a PRI as a qualifying distribution in the year in which it is made (essentially the same treatment afforded grants). These tax provisions have allowed foundations to creatively use their assets in situations where grant making is either inappropriate or insufficient.

Grants generally can be made only to nonprofit organizations. However, a for-profit entity that conducts business which advances an exempt purpose, such as building affordable housing or stimulating economic activity in underserved markets, could receive a PRI. Also, when nonprofits are involved in projects that require substantial financial resources, they are frequently able to raise greater sums through loans than otherwise available as grants. PRIs are most frequently loans, but they also include loan guarantees, linked deposits and equity investments.

The Foundation Center’s new PRI Directory includes nearly 200 PRI providers. (See http://fdncenter.org.) Not surprisingly, housing and community development organizations have received far more PRIs than any other type of nonprofit organization. They are often used to close gaps between sources and uses, or to reduce debt service costs so that overall expenses at least equal projected revenues.

Securing a PRI is similar to getting a grant, but there are some important differences.

More up-front information
Grant proposals typically include an organization’s history and mission, tax status, programs offered and constituencies served, a detailed project description, justification of need, goals and objectives, a timeline, qualifications of key personnel, a project budget, an organizational budget for the duration of the project and the organization’s most recent audited financial statements. For a PRI, this material is still relevant, but more information is needed.

For a PRI real estate loan, for example, an applicant must provide, at a bare minimum, a detailed statement on the sources and uses of capital needed to complete the project and a projection of income and expenses covering at least the duration of the proposed investment. These – and backup material that clarifies the assumptions embodied in them – enable the foundation to analyze how its investment would fit within the structure of the deal and whether sufficient cash flow exists to repay the PRI as proposed. If the property will be used to secure repayment of the loan, both the historical and post-redevelopment appraised value of the property, must be determined, along with the collateral position of the foundation relative to other lenders. (With a loan guaranty, where the foundation is being asked to repay the entire face value of a loan in the event of default, the appraised value of the collateral may be the most significant determining factor.)

A linked-deposit proposal is somewhat different. In this case the foundation places money with a bank or credit union as an inducement to make loans that advance a philanthropic purpose, frequently using its earned interest to reduce the effective interest rate charged. As long as the foundation’s deposit will not be used to repay lenders in the event of default, it will be interested in the financial status of the depository institution – not the proposed project.

There are a variety of other kinds of PRIs, but in general, the more novel the form of the investment or the more complex the project, the more detailed the information requests (and the closing paperwork and reporting for the life of the PRI).

More Negotiation
Unlike grant reviews, discussions around a potential PRI are not likely to fit neatly into a prescribed pattern, with a single yes/no decision; they involve continuous and evolving negotiation. This is partially because PRIs are often used for gap financing, where the details of project financing start off fluid, with numerous funding sources being negotiated concurrently. The foundation may also be negotiating to meet internal requirements of its portfolio.

Worth It
The complications in obtaining PRIs may appear daunting at first glance, but they should not be overlooked as a useful source of project financing.

Copyright 2001

Robert Jaquay is associate director of the George Gund Foundation. For many years, through grants and program-related investments, the Gund Foundation has been a prominent supporter of neighborhood development in Cleveland, OH.



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