Private Philanthropy

Creative Uses of Program Related Investments

The International Journal
of Not-for-Profit Law

Volume 1, Issue 3, March 1999

The Charity Commission for England and Wales has under consideration a law revision that would permit charities to engage in activities that promote urban/rural regeneration and relief of high unemployment or charitable objectives in their own right. Pension funds would also have to declare that they have ethical/social investment policies in this direction. The effect of the change for charities would allow charitable trusts to make grants and investments in this field on their own merits as charitable activity. Attempting to address and alleviate issues involving urban decay and unemployment in economically depressed areas has long been considered to be a charitable activity under United States tax law. Similarly, these purposes would appear to meet the fourth category of charity described by Lord MacNaughten in Income Tax Special Purposes v. Pemsel (1891) AC 531 as “other purposes beneficial to the community.” This broad category of charity provides for the changing needs of society. In the United States, we refer to it as a “program related investment”. This article will review the PRI concept in the context of the charitable law of a country like the United States and than see its application in an emerging country like South Africa.

The concept of a program-related investment (“PRI”) in the United States had its earliest beginnings with a £2,000 bequest by Benjamin Franklin to create a revolving loan fund for young artisans. More recently, President Lydon Johnson’s War on Poverty was built on relieving poverty, in part, by rebuilding economically distressed communities through capital formation for low-income housing and small business development that provided employment opportunities and needed services. Private foundations like Ford, Rockefeller, Russell Sage and Taconic were the early leaders in this area. They funded the Cooperative Assistance Fund to invest the assets of many private foundations in support of minority community enterprises that could not obtain financing because of racial discrimination. These investments served as the engines to power equity financing and loans to entrepreneurial businesses and community organizations making socially responsible investments furthering charitable goals without any likelihood of profit.

Prior to 1969, private foundations could within the provisions of the United States Internal Revenue Code invest their principal assets in any form of investment without jeopardizing their tax-exempt status. United States Congress became concerned that certain private foundations were investing their assets in speculative oil and gas transactions. Warrants, commodity futures, margin sales and other transactions that put in risk their assets and jeopardized their carrying out of their charitable program. At the same time other foundations were loaning funds to organizations that were carrying out necessary community services and but for this assistance would not have been able to operate. Thus, congress enacted section 4944 that precluded foundations from engaging in high-risk investments unless those investments accomplished a charitable purpose. In the United States PRIs are well suited for addressing broad social concerns by combating community deterioration and relieving poverty. They increase economic opportunities through investment in minority-owned business enterprises in deteriorated neighborhoods, or in businesses that employ low-income persons. Foundations use PRIs to finance projects that help maintain a healthy center city and the continued vitality of established neighborhoods. They can also work through financial intermediaries that in turn lend to businesses that create jobs. PRIs may be made to either nonprofit or for-profit corporations as long as the primary purpose for making the PRI is charitable.1

Program-related investments. A program-related investment is an investment that (1) has the primary purpose of accomplishing one or more of the charitable purposes described in the Code; (2) doesn’t have as a significant purpose the production of income or the appreciation of property, and (3) isn’t intended to accomplish any purpose relating to legislative or political activity. Reg. § 53.4944-3.

The investment will be deemed primarily to accomplish charitable purposes if it significantly furthers accomplishment of the foundation’s exempt activities and if it wouldn’t have been made, but for the relationship between the investment and the accomplishment of these exempt activities. An investment may carry out a charitable purpose, whether or not these purposes are carried out by recognized charities. Thus, a recipient of a program-related investment needn’t be a tax exempt organization. Also, investments in a functionally related activity of a charity are treated as made primarily to accomplish charitable purposes.

A significant factor in determining whether an investment is program-related is whether investors who invest solely for profit would be likely to make the same investment on the same terms as the private foundation. If not, this fact indicates that the investment wasn’t made for the production of income or appreciation of property as a significant purpose. Nevertheless, the fact that the investment does produce profit or appreciation isn’t conclusive that it was entered into for such purpose.

Once a program-related investment had been made, it will continue to qualify as one so long as any changes in the form or terms of the investment are made primarily for exempt, and not profit-making or income-producing, purposes. Changes in the form or terms of an investment for the protection of the foundation’s investment will ordinarily not affect its status as program-related.

Here are some examples of program-related investments contained in Treasury Regulations:

Example (1). A loan to a small business enterprise located in a deteriorated urban area and owned by members of an economically disadvantaged minority group, if bank loans are unavailable and the loan is made at interest below the market rate for commercial loans of comparable risk.

Example (2). A purchase of common stock of a small business enterprise located in a deteriorated urban area owned by members of an economically disadvantaged group if banks and other conventional sources of funds are unwilling to provide funds for the business at reasonable interest rates unless it increases the amount of its equity and capital.

Example (3). A loan made to a business enterprise that’s of continued importance to the economic well-being of a deteriorated urban area because it employs a substantial number of low-income persons for such area, and conventional sources of funds at reasonable interest rates are unavailable.

Example (4). An interest-free loan to a socially and economically disadvantaged individual to enable individual tenable him to attend college.

Example (5). A high-risk investment in low-income housing, if the primary purpose in making the investment is to finance the purchase, rehabilitation, and construction of housing for low-income persons.

These examples fit squarely into the charitable activities that promote social welfare under section 501(c)(3) of the Code because their purpose is to lessen neighborhood tensions, eliminate prejudice and combat community deterioration which form the basis of what is “charitable” under section 501(c)(3) of the regulations.

In order to avoid any potential private benefit, the production of income or the appreciation of property must not be a significant purpose of the PRI. The fact that a profit results from the activity is not determinative of whether the PRI has a charitable purpose.2 In determining whether a charitable purpose is present in a loan, one must look to such factors as:

  • Whether the interest rate is substantially below market.
  • If the interest is at market, whether the risk would be higher than what a conventional lender would take on.3

The same rationale applies to equity investments. They meet the PRI requirements if they are, on their face, riskier than for-profit investments that ordinarily will not receive commercial funding. For example, PRIs generally include equity investments:

  • For a new venture with an untested market.
  • For an activity operating at a lower level of capitalization than a conventionally structured investment.
  • That show less-favorable collateral or prepayment terms than conventional investments in the same project.4

The PRI, like a charitable grant, allows a private foundation to meet its charitable distribution requirements.

A recent excellent example of this type of PRI involved a private foundation whose charitable purpose was to rehabilitate a specific geographical area through economic development, job creation, and assistance to existing and developing enterprises. The population of the area was composed substantially of minorities. There the foundation provided its services substantially without charge and limited its equity interests to 3% of the project. This resulted in limited income generated for the foundation. The foundation accomplished this purpose by funding a business incubator that nurtured businesses providing a number of services and facilities. When the business was viable, it was relocated into the local community.

Thus as a matter of tax policy,the United States Code recognizes the PRI as an appropriate means for a private foundation to further its charitable program. The Code recognizes and, in effect, subsidizes this activity through the use of contributions allows the distribution to be treated as a program expenditure and does not treat the activity as an excess business holding.

Accomplishments and barriers. PRIs have proven themselves to be an effective tool for promoting community development. Recipients have said that PRIs have helped them achieve the goals of their projects, not only by improving their financial position, but by augmenting their managerial capacity. In the opinion of many private foundations that have made these type of investments, PRIs have helped by adding to the financial strength of the recipient organizations and also by supplementing needed management skills.

PRIs have been found particularly well-suited to supporting capital projects by providing “bridge financing” and construction loans. Most foundations making PRIs have used them to fund individual projects. Support of intermediary organizations, such as credit unions, venture capital and loan funds, and development banks is growing. It is estimated that three out of four PRI loans primarily support nonprofit organizations.

A troublesome default rate of nearly 60% on loans plagued early PRI portfolios and resulted in less use of this financing vehicle than might otherwise be the case. Several reasons accounted for this. First, poor business management practices by the borrower led to business bankruptcies. Second, lack of education and training of the borrowers led to marginal activities. Third, less than adequate review and ongoing interest by the private foundation lender resulted in lost assets. The default rate now has been reduced to 10%. Another barrier for the relatively small number of foundations making PRIs stemmed only partly from the lack of business experience — other reasons lie with the foundations themselves — either because of insufficient asset bases, or an institutional preference for the more familiar grant.

The program related investments can also apply beyond the inner city to rural areas, environmental issues and other public purposes. For example, an environmental organization may be operated for the purpose of protecting globally significant natural resources encompassing pristine coastal wetlands and marshlands farms. The land may be designated by the United Nations as a Biosphere Reserve to serve as a model of how people can live in harmony with nature. The area, while rich in natural and cultural resources, has poor economic conditions and is therefore threatened with inappropriate development that could destroy the surrounding environment. To develop a plan for compatible economic development, the organization, private investors, and local partners established/ a Sustainable Development Corporation (SDC) to develop and support products, business ventures, and land uses that enhance the local economy and achieve community goals that preserve the environment. To provide sufficient capital, a private foundation provided a ten-year loan to the SDC for $500,000 at an interest rate of 2% per year with full recourse to the assets of the SDC in the event of default.

Private foundations also use PRIs to capitalize community development corporations (CDCs) to create jobs and economic opportunities for low-income individuals by financing and providing technical assistance to job-generating small businesses. The CDC may also establish a wholly owned for-profit subsidiary to make equity investments. The CDC serves as the only general partner in the limited partnership with commercial investors. The limited partnership invests in businesses that the CDC determines will (1) meet certain social and environmental concerns, and (2) produce innovative business solutions to significant social and environmental problems. The CDC receives an annual management fee of 3% of the committed capital from equity co-investors and debt sources. In this situation the limited partnership receives a loan of $1 million from several foundations at an interest rate of 1%, payable annually on the unpaid balance. The loan is payable in full on the 12th anniversary of its closing date. Any interest accrued or unpaid on or after that date is payable on demand.

PRI on a Small and Broad Scale

Microcredits and Venture Capital Funds.One popular form of international loans are microcredits. Microcredits are small loans to budding entrepreneurs in impoverished areas. The first microcredit apparently originated in Bangladesh, where in the 1970s a banker named Muhammad Yunus pioneered the practice of giving poor people — mostly women — small loans to help them start businesses. Microcredits have since seen an incredible boom. For example, Action International of Somerville, Massachusetts, has seen the loans made by it and its affiliates in Latin America and the United States grow to $331 million as of 1995. Microcredits are often also linked with the concept of community banks, which concentrate their lending in poor and run-down neighborhoods.

Microcredit programs tend to heavily rely on foundation grants, government programs, and private donations for their capital. To avoid this reliance, some U.S. charities are now seeking to develop venture-capital funds to invest in projects that are too costly for microcredit programs to handle, such as a food-processing plant that can serve scores of small farmers, but which also serve poor communities. The capital for these funds would come primarily from private investors.

South Africa has initiated a series of program related microcredit investments through the assistance of private foundations that fund intermediate loan organizations.

The NuBank, a division of ABSA, is a leader in microlending and has helped to integrate and link the forces of social and business expansion that have been created as a result of the huge income disparities in post-apartheid South Africa. The experience of microfinancing has not been an unqualified success by any measure. Standard Bank started a microlending program in 1992. Its problems were not with bad loans but rather with the high level of operating costs. This resulted in high interest rates of 50 to 100 percent to make a reasonable return for the bank. A more serious attempt to provide financing for business development has been spearheaded by the volunteer sector with several NGOs active in this area.

The Get Ahead Foundation, headquartered in Pretoria, is a prime example of the “new breed” of NGO. suffering initial losses in its loan portfolio, it relied on grant financing to keep solvent. Now through more business-like efforts, Get Ahead is making a 7.5 percent return on its total assets, controlling its costs and reducing its loan loss ratio from 4 percent to 3 percent. For the microfinancing operations which are too large for foundations but too small for commercial banks, a third-tier institution like the NuBank is a good model to follow to mobilize savings, tightly supervise liquidity requirements, and provide support for good business practices. It expects to make a return on equity from 32 to 35 percent on unsecured loans.

Another example of a large PRI activity is a multinational philanthropy that is coupling low interest loans with strong management expertise and assistance. The Media Development Loan Fund (MDLF), an operating private foundation created by George Soros, was launched on December 1, 1995. With offices in New York City and Prague, its operations now span 15 countries on three continents. MDLF’s mission is to assist indigenous, independent, pluralistic news media — newspaper and magazine publishers, news agencies, radio and television broadcasters, and electronic news publishers — in countries transitioning to democracy which typically face government harassment, competition from well-financed state-controlled media, discriminatory banking policies and lack of available capital sources. MDLF’s attempts to create a level playing field, primarily by providing low interest loans combined with management training and other technical assistance.

MDLF has developed a unique approach to the lending process that has proven to be very successful. Initially, MDLF’s board of trustees determines that a candidate’s media enterprise is worthy of support, i.e., that it is independent of government and political parties, free of foreign ownership, and strives for responsible fact-based journalism. Following this preliminary approval, the candidate is required to submit a highly detailed business plan for use of the loan, which must demonstrate the candidate’s ability to generate sufficient income to repay the loan in full. With assistance from MDLF’s team of media management experts, the business plan writing process (which often takes months) teaches and requires the candidate to rigorously examine and reconfigure its operations and business strategy using sophisticated Western management techniques. Then, after the loan is approved, MDLF’s strict loan reporting and procedures require the borrower to continue using these management methods, so that over time they are woven into the borrower’s operations and management culture.

Through March 1998, MDLF has made 14 low interest loans and other financings totaling approximately US $4 million to 10 media institutions in 6 countries. The largest loan has been $1.5 million, the smallest $20,000, with the typical loan running between $150,000 to $250,000. The average interest rate has been 2.5 percent. Typically, the MDLF gives its loans for a specific use, such as the purchase of a printing press or upgrading of broadcasting equipment. In addition to loans, MDLF has extended approximately $165,000 in technical assistance to its borrowers, mainly in the form of management and other training, as well as assistance in installing equipment purchased with the proceeds of the loan. Every loan made by MDLF is performing exceptionally well. Not one dollar has been lost, and no principal or interest payments has ever been.


Tax-exempt organizations are again being asked to play a major role in assisting the poor and disenfranchised throughout the world. Governments are reviewing their laws to determine whether NGOs should be permitted to engage in program related investments to further public benefit. The tax laws of various countries in the Americas, Europe, Africa and Asia take into consideration charity in this broader context, as reflected in Lord MacNaughten’s fourth category of charity, to permit charitable organizations to engage in commercial activities related to accomplishing their core purposes. Certainly the program related investment is a vehicle worth considering that produces innovative programs that provides substantial development and opportunities to communities seeking renewal for their people and their economic base.


1 See Reg. 53.4944-3(b) for various examples.

2 Reg. 53.4944-3(a)(2)(iii); GCM 38920, 5/26/80.

3 Ltr. Ruls. 8710076, 8637120, 8141025; GCM 33906, 8/7/68. See also rev. Ruls. 73-128, 1973-1 CB 222; 73-313, 1973-3CB 174.

4 See Ltr. Ruls. 8807048, 8242068; GCM 39720, 3/30/88.