"One to 70," he added. "[That's] dramatic leverage by anyone's count."
But here's the kicker: When foundations make investments that further their charitable goals, the principal must be recycled as yet another grant-or PRI. In this way, foundations can compound their do-good impact.
Is it any wonder that the Gates Foundation has increased its PRI budget from $400 million to $1 billion?
This is a two-part series about PRIs. In part one, we will trace their evolution as a form of social venture capital, focusing on their use in the nonprofit world. In part two, we will address the issues raised by using PRIs in the commercial world, and show how they are being used to transform for-profit companies and even entire industrial sectors.
Legalizing Philanthropic Investment
Although PRIs can be traced back to 13th century England, their origin in this country is said to be a revolving-loan fund endowed by Benjamin Franklin to provide start-up capital to artisans and young tradesmen. Rather than bestowing gifts, the idea was that repaying loans at 5% would ensure that the funds would be available for future generations. According to Global Impact Investing Network CEO Luther Ragin, who described this fund at a PRI Makers Network conference in 2006, the trust's default rate was so "staggeringly" low that the value of the endowment had mushroomed nearly 17-fold by 1990, when the cities of Philadelphia and Boston split the remainder of the trust.
According to Investing for Social Gain: Reflections on Two Decades of Social Investments, a l991 report by the Ford Foundation, another early social investor was American George Peabody, who invented a limited-dividend company to develop and manage low-income housing projects in England. The slogan for other wealthy Americans and English who invested in 19th century housing reform projects at a 5% fixed rate was "philanthropy at five."
Fast-forward to the late l960s, when Louis Winnick, a former deputy vice president at the Ford Foundation, received a grant proposal from a group that offered to provide minority youth with on-the-job training for their work on the rehabilitation of a building. "The project was going to end up creating an asset that would generate revenue," he was quoted as saying in a Ford Foundation report. "It occurred to me that we could have done this as a loan."
Foundations are not only required to maximize investment returns, they are also prohibited from taking risks that jeopardize the value of their endowments and thus their grant-making ability. Modern portfolio theory, or MPT, permits riskier investments as long as they are made with care and are within the purview of a broadly diversified portfolio, and some foundations today devote a small portion of their endowment to PRIs. But this was the late l960s, before MPT was institutionalized or became mainstream.
As Winnick explored the economics of making "soft loans" to minority businesses and ventures like low-income housing, he teamed up with John G. Simon, the Taconic Foundation president and a Yale Law School professor, who looked into whether foundations could legally set aside the fiduciary obligation to maximize returns to make investments focused on social goals. Ultimately, when the PRI was established in the Tax Reform Act of l969, the law effectively gave foundations an alternative to straight investments and giving away money by allowing foundations to engage in low-return social investments-as long as their primary purpose was charitable.
Social Venture Capital
Like modern portfolio theory, venture capital was not mainstream in the l960s. But by establishing the PRI as an alternative to a grant as part of their required charitable distribution budget, foundations could engage in social venture capital. In effect, a foundation could make a risky social investment that otherwise might be considered a jeopardizing investment, and the worst-case scenario was that it would fail-and the foundation would then write it off. From a financial perspective, this is arguably equivalent to making a grant, which it would have made anyway.