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THE LEGAL DEFINITION & REQUIREMENTS
PRIs are the historical product of the Tax Reform Act of 1969, which, among other things, imposes fines on foundations if they make "jeopardizing investments" - that is, any investment (including any loan) that could imperil the foundation's ability to carry out its charitable activities. Program-related investments are the exception to the rule. Under Section 4944, private foundations are allowed to make "program-related investments" that meet three criteria:
If the recipient of the program-related investment is not a public charity, the foundation is required to exercise expenditure responsibility. The expenditure responsibility requirements for a PRI are somewhat more stringent than for regular grants. As explained in one large foundation's standard PRI opinion letter: "[E]xpenditure responsibility … means that the private foundation is responsible to exert all reasonable efforts and to establish adequate procedures
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The investment's primary purpose must be to advance the foundation's charitable objectives. Essentially, the foundation has to show that it would not have made the investment but for its relationship to the foundation's tax-exempt activities.
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The investment's primary purpose must be to advance the foundation's charitable objectives. Essentially, the foundation has to show that it would not have made the investment but for its relationship to the foundation's tax-exempt activities.
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Neither the production of income nor appreciation of property can be a significant purpose. Lawyers generally apply a simple litmus test here: Would an investor solely engaged in investing for profit make the investment on the same terms? When the answer is no, it means the foundation is accepting higher risk and lower returns.
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The funds cannot be used directly or indirectly to lobby or for political purposes. Simple enough, but an important distinction from grants, which can, with certain limits, be used for lobbying. (See GrantCraft's guide Funding Advocacy: The Philanthropy of Changing Minds, for more information on the rules regarding grants.)
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Public foundations have somewhat more freedom - but some public foundations use the IRS guidelines voluntarily in the interest of "fiduciary prudence," as one foundation executive put it.
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PRI accounting. The accounting for PRIs is fairly straightforward. A PRI counts toward a foundation’s required 5 percent charitable distribution in the year it is disbursed to the borrower. PRI principal repayments count as a "negative distribution" against the foundation's payout requirement in the year the principal is repaid - in other words, a $500,000 repayment must go out again in grants or new investments in the year it is repaid. Interest, dividends, and capital appreciation count as regular income.
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Legal compliance. The IRS rules governing charitability are complicated, and the implications for innovative projects may be nuanced. Some foundations therefore insist on getting an opinion letter from a lawyer confirming that a PRI meets the legal requirements before making an investment. (If the IRS disallows a PRI, it can be considered a jeopardizing investment for which the foundation and its managers can be fined; having a legal opinion usually allows the foundation’s managers to avoid penalties since it demonstrates that the investment was made in good faith.) In rare cases, a foundation may nix a deal because a lawyer finds that it lacks a legally sufficient charitable purpose, or because it could be financed through traditional means. The upshot, said one investor, is this: "Talk to a lawyer and make sure it's someone who has done PRIs before" - and do it early on.
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