January 27, 2014
Authored by: Megan S. Acosta
A program related investment (PRI) is a powerful tool for a private foundation to positively influence social enterprise while advancing its philanthropy and satisfying its 5% annual minimum distribution requirement.
Traditionally, private foundations have used grant-making activities as the primary means to satisfy their 5% annual minimum payout requirement and to accomplish their tax exempt purposes. However, modern trends reveal a new focus of private foundations on PRIs to achieve the same results.
What is a PRI?
A PRI is an investment, rather than a grant, whose primary purpose is to achieve one or more of the private foundation’s tax exempt purposes and no significant purposes of which is the production of income or the appreciation of property. However, the fact that an investment produces significant income or capital appreciation is not conclusive evidence that income or appreciation was a significant purpose of the investment, and, therefore, does not preclude the investment from being a valid PRI. As a practical matter, many PRIs produce income or capital appreciation. The test is whether the production of income or capital appreciation is a significant purpose of the investment over the tax exempt purposes of the investment. As long as the tax exempt purpose of the investment is strong, the production of income or capital appreciation should be viewed as a mere ancillary benefit.
A PRI is also a great benefit to a private foundation. PRI counts towards a foundation’s qualifying distributions just as if they were grants and are exempt from the excess business holdings tax (imposed on foundation investments that exceed 20 percent of a for-profit venture) and the jeopardizing investment tax (imposed on investments that jeopardize the tax exempt purposes of a foundation).
Why haven’t you heard of a PRI?
PRIs are underutilized and have been labeled by the legal community as too risky for the average private foundation due to the lack of IRS guidance on what qualifies as a PRI. However, the landscape is beginning to change in response to the proposed regulations issued by the IRS in 2012. Moreover, more practitioners have realized that if properly structured, there is little risk in attempting to make a PRI. A failed PRI is merely treated as a regular foundation investment. Thus, so long as a PRI is structured within the limitations applicable to general foundation investments including, without limitation, the excess business holding and jeopardizing investment rules, there are very few reasons why an average foundation should avoid making PRIs.
Many states have adopted legislation to create socially minded for-profit entities. For example, on January 1, 2012, two California bills became effective that create new forms of California corporate entities. AB 361 creates the benefit corporation or B-corp while SB 201 creates the flexible purpose corporation or FPC. Unlike the traditional corporation, B-corps and FPCs now allow for-profit businesses to serve a socially minded purpose without having to maximize shareholder return. One major goal of the new legislation is to encourage private foundations to fund more social enterprises through PRIs. Because of the socially minded purposes of these new entities, private foundations may feel more comfortable that an investment in such vehicle should qualify as a valid PRI.
How does a PRI work?
Instead of giving money away through grants, PRIs allow private foundations to make investments in for-profit business enterprises and individuals. Such PRIs may be made in the form of an investment in the corporate stock of a corporation, the capital or profits interest of a limited liability company or even as a loan to a for-profit business enterprise and individual.
For example, in 2011, the Bill & Melinda Gates Foundation made a $10,000,000 equity investment in a for-profit biotechnology company, Liquidia Technologies, to support the development and commercialization of safer and more effective vaccines and therapeutics. Later that same year, the foundation established a $400 million fund dedicated exclusively to making PRIs. See “The Gates Foundation Reveals How It Makes Program-Related Investments,” Chronicle of Philanthropy (4/5/2011). Other foundations (which prefer to remain anonymous) choose to extend loans to for profit businesses that are actively engaged in services, products or ideas that further the tax exempt purposes of the foundations.
For more information on PRIs or private foundations, please contact a member of our Tax Exempt and Charitable Planning Team.