Editors Note: This piece was originally published on locavesting.com.
“It’s like startup nation! There are so many different businesses. And there’s so much money out there—and you can find these people.” – Joanne Wilson, Angel Investor, NYC
Great advice, right? Then why do so many entrepreneurs and investors struggle to find one another?
The answer is that yes, there is a lot of money out there, but not all of it is right for a young business. Startup maturity, risk profile and readiness for capital can vary widely. This challenge is amplified when the business seeking capital is a social impact, mission-driven enterprise.
Mission-based entrepreneurs and investors have traditionally faced a narrow set of choices. Nonprofits could solicit grants. Profit-based companies looked for bank loans or venture capital, usually equity investment. The terms of these agreements were predicated on market-based assumptions of profit, return and scale. Social enterprises add a social impact mission to their business model, which sometimes constrains profit maximization and growth and can make these businesses simultaneously ineligible for grants and not competitive for traditional bank loans or venture investment.
That’s where Program Related Investments (PRIs) come in. This underutilized tool has been gaining traction recently for social impact investors and entrepreneurs as a middle ground between charitable grants and for-profit investments that can provide low-cost capital to mission-driven companies while allowing foundations to stretch their limited dollars for maximum impact. Because foundations can recoup their principal and even generate a return, they can recycle that money into additional impact investments.
Program Related Investments must be "Mission First"
For foundations of all sizes, PRIs can be a great tool to support social entrepreneurs, prove new business models, catalyze additional investment, and recycle donor dollars to achieve greater impact. PRIs can be used to test the viability of a new model when the financial risk-return profile is unattractive to a traditional investor, but the potential rewards are high in terms of social or environmental impact.
PRIs differ from other types of investment in that they MUST be mission first, according to the IRS. However, they can also produce financial returns as a secondary investment purpose. PRIs can be made to both non-profit and for-profit entities; in the latter case, an IRS-approved expenditure responsibility process should be followed to document the charitable intention of the investment.
Family Foundations and PRI: Woodcock Foundation's Experience
A handful of big foundations, including the Gates Foundation, have led the charge on this kind of impact investing, which may have created the impression for some that the average foundation is making PRIs. However,research from the Foundation Center’s GrantSpace found that of the thousands of grantmaking foundations in the US, just a few hundred make PRIs. In addition, just a third of PRI funders maintain formal PRI programs or make PRIs on an annual basis.
Small and mid-sized family foundations, in particular, have an opportunity to use this new tool to achieve impact, but it can take time to get comfortable with the idea and the process.
The Woodcock Foundation is a medium-sized family foundation that over the last decade has begun to make program-related investing a part of its mission, which is to support community development with a focus on improving education, entrepreneurship and the environment. Since its founding, Woodcock has made grants primarily in the areas of social enterprise and economic development, food systems, large landscape conservation, education, media & democracy, gender equality, and civil society.
Several years ago, the Woodcock Foundation began to look at PRIs as a way to complement its grantmaking with a more investment-oriented approach. The foundation wanted to be able to support enterprises that it felt were likely to make long-term change in their communities, and had a financially sustainable model for doing it, and that were not necessarily configured as a nonprofit. The foundation was also interested in PRIs as a way to have impact in the present while preserving some of its capital for long-term impact.
Woodcock’s PRI with Root Capital is an example of this approach. Root Capitalis an organization that works as an agricultural impact investor in Africa and Latin America (photos above and below). It raises money through grants or low cost debt and loans it out to farmers. Based on Root Capital’s track record, the investment risk was modest. But with a low interest rate, it fell into the “concessionary” capital category—in other words, a traditional investor would be unlikely to make such an investment because the financial return is considered below market value. However, for a foundation, below market valuation is a reasonable trade-off when paired with a social environmental return.
Woodcock considered making a grant, but the PRI offered an opportunity to make an impact on the agricultural sector of developing economies and support farmers while also getting more impact out of its capital by recycling it for additional impact in the future. The foundation chose to make a low-interest (2%), three-year loan to Root Capital in the form of a PRI.
The experience was so positive for both parties, that after the loan term ended, Woodcock went on to make a second PRI to Root Capital on similar terms, providing capital to support additional agricultural businesses and producers.
From the grantmaker’s perspective, Woodcock was able to stretch its dollars further and received value out of the investment by accomplishing a social objective. In this way, even a low- or no-interest PRI can make a lot of sense.
A PRI was attractive to Root Capital, too. The low-cost capital from the Woodcock Foundation allows Root Capital to in turn lend to growing agricultural businesses in vulnerable areas and link them to international markets, says Willy Foote, founder and CEO of Root Capital. “When they grow,” he adds, “there’s a cascade of ripple effects that occur: livelihoods for farmers and employees increase, women and girls achieve more economic freedom, and communities thrive.”
PRIs are often compared with investments, but in reality they are a tool on the spectrum between grants and traditional investments. With a grant, the foundation is agreeing from the beginning to take a 100% loss on its capital as a trade-off for the impact expectations. Compared to a grant where the foundation is conceding all of the capital in exchange for impact, a below market-interest PRI that helps the foundation accomplish its mission can be a highly effective approach. While PRIs are not the best choice for every social impact scenario, their results are measurable and allow both the grantmaker and the entrepreneur to test social entrepreneurial hypotheses in the market.
Equity-based Program Related Investment
PRIs are often structured as a low-interest loan, but they can also take the form of an equity investment.
Recently, Woodcock was interested in supporting sustainable farmland, and access to land for farmers in the Northeast, where land can be prohibitively expensive. It considered both grants and PRIs as two tools in its toolbox and settled on a PRI to Copake Agricultural Center (a project of Northeast Farm Access) after recognizing the opportunity to achieve a programmatic impact while supporting a new farmland ownership model. The PRI in this case took the form of an equity investment in a multi-party LLC. The LLC brought together private investors to purchase the land in support of long-term farmland conservation and then rents that land at below market cost to young farmers, while also providing training and market access for the farmers.
Like any seed stage equity investor, Woodcock understands that Copake is a longer-term, higher risk investment and it will be monitoring whether the model will work from a financial perspective. However, from an impact perspective, land has been conserved for organic farming purposes; several farms have already yielded crops and provided food to local communities, as well as to the Boston and NYC markets; jobs have been provided to young farmers; and the Center has run been programming to educate the next generation of farmers on a variety of best practices and techniques.
“PRI combines the philanthropic instinct with the belief that an entrepreneurial approach can generate both financial and social returns,” says Jacob Meyer, Co-General Counsel at Northeast Farm Access. “Foundations are therefore uniquely positioned to bridge the gap between charity and social investing. In our work at Northeast Farm Access, we have found that while private investors may face a variety of external demands on their capital, foundations’ core purpose —to do social good—means they are able to offer the kind of patient capital that a land- and community-based project like the Copake Agricultural Center requires.”
Entrepreneurs need to understand that a PRI is not a grant, it is an investment and must be treated accordingly. However, a PRI can provide the absolutely critical financial runway that a social enterprise needs in order to allow it to take the risks needed in the early stage of the business or for testing a new idea that has earned revenue potential. Importantly, PRIs adjust the dynamic between a grantor and a grantee into a partnership where both entrepreneurs and grantmakers are sharing risk in pursuit of a mission-driven goal.
Root Capital’s Foote sums up the scale and impact of a PRI from a family foundation like Woodcock: “Root Capital serves communities where markets don’t work, places where traditional investment capital doesn’t reach. Foundations, like the Woodcock Foundation and others, are critical partners because they’re able to offer PRIs that provide mission-aligned and often-long term capital at scale that enables us to lend to over 300 businesses a year that are providing higher incomes for some 500,000 farmers.”
Getting Started With PRIs: The Woodcock Process
So how can small and mid-sized foundations get started? Woodstock’s experience is instructive. Before Woodcock made its first PRI in 2008, there was an education process. The foundation’s financial and legal advisors had to get comfortable with PRIs, and the board and staff alike had to understand what they were and how best to use them. Beyond understanding PRIs, the team also had to figure out a process for Woodcock. For all but the largest foundations, some of which have set up a PRI department with dedicated staff, capacity can be a question. Who identifies opportunities? Who conducts due diligence? Who approves the PRI in concept, and who approves the contract? Woodcock had to build its internal capacity at the board and staff level to ensure that they were ready to use PRIs to full advantage.At Woodcock, PRI sourcing can come from all directions. Trustees who come across opportunities will bring them to the table. Financial advisors pass ideas to foundation staff when they’re not a good fit for a mission-related investment. And staff sources ideas based on Trustee interests and priorities. Over time, the team has refined the process for considering PRIs to make it consistent and clear by establishing procedures for involving various parties in decision-making and adopting a standardized due diligence template. Due diligence can include documentation from co-investment partners, too.
Strategic Questions for Foundations and Entrepreneurs Considering PRIs
As Woodcock has considered how much PRI-making to engage in, numerous questions have come up that don’t have right or wrong answers; rather, the answers depend on the interests and intent of an individual foundation. One such question is what level of risk is the foundation willing to take. A foundation could aim to preserve capital to demonstrate that PRIs can succeed in having both financial and social/environmental returns, but this likely means taking a lower level of risk. On the other hand, like venture capital, PRIs can be used to support highly innovative, but unproven social business models, which requires being willing to take risks and potentially lose capital. And of course, if a foundation is willing to make numerous PRIs, it can test both strategies, which has been Woodcock’s approach so far.On the mission side, the foundation can consider whether to use PRIs to augment existing program areas or to support new interests, whether to favor opportunities to invest in funds or make direct investments, and what types of investments they’re comfortable making across different geographies.