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Does a manufacturing facility need money to rapidly convert its operations to produce critical parts for respirators, or protective gear for health care workers? Is there a startup looking to produce emergency shelters and aid stations from the empty shipping containers piling up at the docks? Are vaccine developers in need of massive funding to rapidly research and test new candidates at speeds never seen before?1 Is there a web developer out there who can (please) help create a "Zoom for the Classroom" or another online, video-conferencing app for teachers (with a "raise my hand" function for kids to then be unmuted by the teacher, one kid at a time)? Will an important commercial employer fail without extra support?
Yes, on all counts, and the enormous wealth in U.S. private foundations can be unleashed to help. Private foundations can fund these types of endeavors through investments - startup funding, stock purchases, LLC purchases, low or no interest loans, scientific research grants that ask for a royalty for successful pharmaceutical discoveries, etc. Program-related investments are an exception to the excise tax on "jeopardizing investments" (i.e., investments that are too risky), and they count as charitable distributions for purposes of the 5% annual minimum distribution requirement (not that 5% is a limit by any means).
What Can a Program-Related Investment Seek to Accomplish?
The primary purpose of a program-related investment is to accomplish one or more exempt purposes, including charitable, educational, scientific and literary purposes. The "official" examples include domestic and international programs for combating environmental deterioration, promoting the arts, providing relief to the poor, educating poor farmers in a developing county, supporting commercial employers in disaster areas, constructing a child care facility in a low-income neighborhood, and furthering "orphan drug" research and development (e.g., finding a vaccine to prevent a disease that predominantly affects the poor in developing countries).
With the entire country effectively now a disaster area, there are now a very broad range of programs that can accomplish a private foundation's exempt purposes through program-related investments, and help ease the suffering caused by this pandemic.
Who Can Receive Program-Related Investments?
Investment recipients can be 501(c)(3) organizations, 501(c)(4) social welfare organizations, foreign and domestic business enterprises and foreign and domestic individuals. Ultimately, the investment recipients serve as the instruments through which a private foundation can seek to further its exempt purposes.
How Can Program-Related Investments Be Structured?
There are no limitations on the financial structures that can be used to make program-related investments. As long as no significant purpose of the investment is the production of income or the appreciation of property, it appears that program-related investments can be structured as straight debt, convertible debt, debt with an "equity kicker," common or preferred equity interests, warrants, loan participations, funded or unfunded loan guarantees, royalty interests or otherwise.
Are Program-Related Investments Limited to Below-Market Returns?
No. Although the production of income or appreciation of property cannot be a significant purpose of a program-related investment, the potential for a high rate of return on an investment does not preclude its qualification as a program-related investment. A royalty interest in diabetes research could lead to a blockbuster return, but the IRS nonetheless approved of such a program-related investment in a 2011 private letter ruling.
Private foundations need not hesitate to make otherwise qualifying program-related investments in a long-shot or a potentially highly successful business, for a COVID-19 treatment, vaccine, or other means to help the nation through this difficult time.
Is a Private Foundation Required to Cash Out of a Successful Program-Related Investment? Does a Program-Related Investment Require an Exit Strategy?
For program-related investments involving indefinite terms, such as equity investments, there does not appear to be any requirement to monetize the investment if, for example, the recipient becomes profitable. The exit strategy for loans is typically clear - private foundations hope to be repaid in full at maturity.
Otherwise, while a defined, advance agreement for an exit does not appear to be a prerequisite to qualification as a program-related investment, private foundations may wish to consider various exit strategies and negotiate appropriate provisions when structuring a program-related investment by including, for example, a "put," "call," forced liquidation, demand or piggy-back registration right, or similar provisions.
How Do We Know If an Investment Qualifies as a PRI?
The examples in the Treasury Regulations can help to support a tax attorney's ability to help make that assessment and, if appropriate (sometimes it's not worth the expense), issue a reasoned legal opinion that a particular investment is more likely than not to qualify, or should qualify, as a program-related investment. A formal tax opinion is often a prerequisite for board approval of a program-related investment and indicates counsel's level of comfort that the proposed investment qualifies as a program-related investment. The tax opinion is particularly important because reasonable reliance on a legal opinion can shield a foundation manager from otherwise applicable excise taxes if the investment is later found to be a jeopardizing investment and not a program-related investment.
Conclusion
It is time for the charitable sector to step boldly into the breach, filling gaps that private enterprise and government cannot. That gap - whether it be funding for scientific research or merely keeping a few small businesses alive - can and should now be filled by the nonprofit sector. One nimble and powerful tool to help make that so is the PRI. Help keep an important local employer afloat, help convert a manufacturing facility to produce respirators and other critical health care supplies, help build emergency shelters and aid stations, help fund vaccine research into this and the next new virus. Private foundations can make these investments now, when no one else can or will.
Footnote
1. The mission of the Coalition for Epidemic Preparedness Innovations US seeks to coordinate the efforts of CEPI's US partners, including private foundations, industry, trade associations, academic and research institutions, and other nonprofits. I'm sure they could help to identify worthy PRI targets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
