Transferring your legacy
A philanthropist’s dilemma in the post-COVID world: Creating the biggest impact
Unprecedented events spur unprecedented thinking. And the onslaught of an unprecedented global pandemic has triggered a desire by investors and philanthropists across the globe to use their investment dollars and charitable gifting power to address intensifying social and economic challenges.
As global health issues have become more acute – while helping to shine a light on education, poverty, environmental, human rights, income, gender and race inequality, and other related issues – wealthy families and philanthropists have looked for investment strategies capable of making deep social impact and acting as catalysts for further social change.
However, these families and philanthropists face important decisions that will determine the impact their philanthropy will have.
The first decision is how much of one’s assets and income to give to charitable causes and how to gift it. While this is well beyond the scope of this article, the historic low interest rate environment and the threat of a tax regime change has triggered structural incentives to undergo complex tax planning schemes and programs that should increase philanthropic giving for decades to come – something the marketplace has yet to discount.
Putting that foundational issue aside for now, the other big decisions pertain to the use of investing as a social tool – what many call mission-related investing, socially responsible investing, catalytic capital, social venture capital, and even Environmental, Social & Governance (ESG) investing – and determining the proper structures to maximize the impacts per dollar.
Impact investing has metamorphosized from a mere concept a decade ago, to a formalized investment strategy and mandate throughout board rooms, institutions, and investment committees across the world. Investors allocated over $1.3 trillion to impact investments worldwide in 2016 and the increasing demand for impact investing products and services has opened new commercial markets for investment firms, fund managers, product platforms, and service providers interested in this growing market.
Investment firms have dedicated and deployed resources to these impact initiatives, and as a result, strategies and dedicated funds have been created to focus on capitalizing on this impact investment trend. Institutional investors, including pension funds, insurance companies, sovereign wealth funds, and private endowments have mandated specific carve-outs of their investment portfolios to impact investing and have made it a permanent part of their investment policies and mission statements to allocate to impact investments.
Where impact investing gets very interesting and effective is when it’s mixed with philanthropy. Mission-related investments (MRIs) and program-related investments (PRIs) are the two distinct and primary tools that can be used by private foundations (and other philanthropic vehicles) to further their mission and impact investing mandates. PRIs must primarily serve a charitable purpose and in many respects are treated similar to grants for tax purposes, while MRIs are fundamentally a financial investment rather than a grant and must meet applicable prudent investor standards similar to more conventional investments.
Despite current common usage, there is no legal definition of an MRI and no legal requirements to qualify for this status. An MRI can be any investment in which the investor intends to generate both a social (including educational or environmental) return as well as a financial return, so that the ultimate goal of the investment is not exclusively about seeking profit.
An MRI is not a charitable activity. In other words, MRIs are made from investment assets rather than program assets, sometimes referred to as “the other 95%” of a private foundation’s endowment assets that are not designated for making charitable qualifying distributions.
Because an MRI is a financial investment, it must be made prudently and satisfy the same investment and fiduciary standards under state and federal law as other investments. Alternatively, MRIs do not need to meet the charitable standards that a PRI must meet, and are typically strategies that are sourced, diligenced, monitored and scored by a research team.
However, charities such as private foundations are held to a higher standard in terms of their fiduciary duties in sourcing, identifying, researching investments, and implementing a diversified portfolio, which may now include prudently selected MRIs. This higher level of fiduciary scrutiny may not be applicable to private funds and investments owned by individuals.
When it comes to charitable activity, the traditional avenue of outright charitable gifting and bequests may not be the best way to maximize a philanthropist’s utility per dollar of gifting in certain circumstances. This is where PRIs can play leading roles.
A PRI must meet specific requirements under the federal tax code to qualify if made by a charitable foundation. A PRI must be primarily for a charitable purpose, must lack any significant investment purpose, and may not be used for electioneering or lobbying. PRIs have proven to be a significant tool to magnify grant making activities.
What makes PRIs especially unique and valuable is that a foundation or endowment can lend capital for specific projects or programs, and when repaid, recycle it to other projects and programs, creating a sustainable pool of capital that can fill gaps in sectors and spaces where markets have failed to permeate for a variety of reasons. These types of PRIs can be aimed at non-profit entities where a traditional charitable bequest would be inapplicable.
The fact that impact investing has become such a major focus for institutional investors has created a market where socially-conscious investment opportunities abound. However, many of the organizations seeking investment may not yet be attractive to institutional investors who are ultimately guided by profit. But this creates an opportunity where philanthropic organizations can use PRIs and their “catalytic capital” to make an impact where institutional investors cannot, while also giving them the power to influence and guide the future of socially-conscious organizations at an early stage.
A key component of PRIs is that they can include below-market loans, preferred/common equity, guarantees, and other instruments, with a strong focus on “additionality” and “catalytic capital.” This helps a foundation direct money towards activity that, in most cases, would not have succeeded without accepting such disproportionate risk and/or concessionary returns relative to a conventional investment.
To summarize, the purpose of PRIs is usually to capitalize on investment opportunities that expand a foundation’s potential for social impact beyond conventional grantmaking while creating a sustainable charitable program that can have a long-lasting impact. Typical examples of PRIs might include:
Examples of post-COVID PRI investments might include:
PRIs can be achieved through a variety of investment types, including loans to individuals, tax-exempt organizations and for-profit organizations; equity/convertible debt investments in for-profit organizations, credit enhancement arrangements and facilities; or even an equity position in conjunction with making a PRI loan.
One thing is certain – the speed with which many families have accumulated wealth in recent years, combined with a widespread and increasing focus on socially-conscious investing that has only been amplified by a global pandemic, is creating an environment for philanthropic activities to thrive.
Ultra-high net worth families who structure their philanthropic activities wisely have an exceptional opportunity to make a lasting impact. There’s a good chance that in the coming years we’ll see large private foundations sitting next to large private equity and venture funds, driving major structuring negotiations on transactions of all types and sizes that impact multiple borders.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.