While there is no actual codified definition, MRIs are generally understood to be risk-adjusted or “prudent” market-rate investments.  It is a financial vehicle made out of the organization’s investment assets (e.g., its endowment) rather than its program assets.  Unlike its counterpart, the Program Related Investment (PRI), which has the primary goal of accomplishing a charitable purpose, an MRI seeks to generate a market rate of return on capital while also furthering a social purpose.  Put another way, PRIs offer solutions where the markets do not have a solution, while MRIs use the power of the market to create impact. 

It’s important for foundations seeking to establish their investment strategy to understand the key legal and structural differences between PRIs and MRIs.  Since the requirements to qualify as a PRI are more stringent than an MRI, a PRI avoids being classified as a jeopardizing investment, and can be counted towards a foundation’s annual distribution requirement.  

An MRI, on the other hand, is a commercial investment that also has a goal to create social impact but is not subject to the stringent standards of the PRI.  Consequently, an MRI does not count towards a foundation’s annual requirement and is not excluded from the rules governing jeopardizing investments.  In addition, in calculating the amount of a foundation’s five percent annual distribution requirement, MRIs are not excluded from the foundation’s assets, as is the case with PRIs. (For an in-depth discussion of PRIs, please read Are You Looking to Make an Impact? Consider a Program Related Investment).  

While the rules governing the MRI are not as rigid as those governing PRIs, there are a few key ones that MRIs must comply with. The “Jeopardizing Investments” rule, found in Section 4944 of the Internal Revenue Code (“Code”), imposes an excise tax on private foundations that invest “any amount in such a manner as to jeopardize the carrying out of its exempt purposes.” A private foundation and its management may be subject to excise taxes for making a jeopardizing or imprudent investment.  Because the Jeopardizing Investments rule applies to MRIs, MRIs must be comprised of prudent investments.

MRIs must also comply with the “Excess Business Holdings Rule.” Section 4943 of the Code states that a foundation, together with its disqualified persons, may own no more than twenty percent of the voting stock of a business enterprise (some exceptions may apply). 

Since MRIs are not treated as a charitable activity but rather as commercial investments, they must meet the prudent investor standards under state and federal law.  The applicable State-enacted version of The Uniform Prudent Management of Institutional Funds Act (UPMIFA) applies a standard for prudent investments whereby “each person responsible for managing and investing an institutional fund shall manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”  In addition, UPMIFA lists a number of factors that must be considered, if relevant, when making an investment.  Most states have adopted a form of UPMIFA. 

Developing an MRI Strategy

The board of an organization that is considering embarking on an MRI strategy should, as a matter of good governance, consider its rationale. Whether as a stand-alone policy or a policy that is incorporated into the organization’s investment policy, drafting a written MRI Policy should be the board’s first step.  The discipline of drafting an MRI policy will ensure that everyone is in agreement when it comes to incorporating MRIs into the overall investment strategy. 

The substance of the MRI Policy will depend in part on the organizational view of MRIs and their purpose.  Some may view MRIs from a programmatic standpoint, wherein the MRI serves as a tool available to the organization in implementing its philanthropic strategy.   Other organizations may view MRIs from an investment perspective and consider it as an opportunity to make a market rate investment that also happens to foster social impact.    

The following is a list of important questions that should be asked when drafting an MRI Policy. 

• Why Does the Organization Want to Make an MRI? 

It’s helpful for an organization to consider what it believes is the key objective for entering into an MRI strategy.  The organization should consider what it hopes to accomplish by making an MRI.  If the full board is in agreement regarding the rationale or objectives for entering into MRIs, it will help support the development of a uniform set of metrics used by the organization when assessing the success of MRIs in achieving those goals.

• Does the organization have the skills and staffing within the organization to carry out an MRI Strategy?  

In order to implement an MRI, organizations will need to rely on individuals with various expertise including investment, programmatic and legal experience.  Executives and the board should determine whether they can utilize in-house staff or board members, or whether they should consider engaging consultants.

The board should take into consideration if it will require a legal opinion that the potential MRI does not qualify as a jeopardizing investment. The size of the MRI relative to the organization’s investment portfolio may be a factor for consideration when determining whether a legal opinion is warranted.  

• Who will be responsible for oversight?  

Prior to entering into an MRI strategy, the board should consider who will be responsible for oversight of the strategy.  If the organization is considering the MRI as a key tool in accomplishing its philanthropic objectives, it may make sense to have both an advisor with programmatic experience as well as one with investment experience onboard. 

On the other hand, if the foundation views the MRI primarily as a market rate investment that also has social impact, a person or committee with investment experience, guided by a board-approved statement of social impact objectives, may suffice.  The investment committee of the board may be an appropriate oversight body for this responsibility when aligned with the foundation’s MRI objectives.  

• What will the balance be between investment risk and social return?

In advance of embarking on an MRI strategy, the board should determine whether it is willing to take a greater financial risk (while still complying with UPMIFA) to the extent the social returns of the investment have the potential to be great.  It may be that, regardless of the potential for social impact results, the board’s appetite for investment risk will remain the same.   Making a riskier investment may require altering existing investments within the organization’s portfolio in order to comply with UPMIFA’s requirement that each individual investment be reviewed in the context of the entire portfolio, in accordance with prudent investor standards.   

Consider the scenario in which the financial rewards are substantial, but the social impact is not as significant.  The answer to these questions will largely depend on how the Board views mission-related investing and why it has decided to enter this arena.  A board would be well-advised to determine in advance of entering into an MRI how it feels about risk and what the appropriate balance is in guiding its MRI strategy.  

• How will the organization measure the success of a Mission Related Investment? 

In reviewing the performance of an MRI, members of the board and management of the foundation should discuss how they intend to measure success.  The foundation could establish that success is based on the investment generating a minimum level of return, while achieving a loosely defined social impact.  For example, investing in a clothing manufacturer that uses environmentally friendly dyes for its fabrics could result in generous returns to its investors but only modest results in terms of reducing harmful environmental impact.  

With a benchmark focusing significantly on market rate returns, an investment that generates modest financial returns but generates substantial social impact may be considered unsuccessful because the return on investment was too low.  The members of the board should consider how much of a social impact they are looking to make through any MRI.   

In Conclusion

The philanthropic sector has come to understand that aligning investments with mission and values can be financially rewarding.  A greater number of foundations have decided to take a portion of their endowment and invest it in ways that align with their mission. Some have decided to invest their entire investment portfolio or endowment in line with their mission.

I predict that in the next few years we are going to see a dynamic shift in the way funders and their boards view their fiduciary obligations. Foundations contemplating entering into MRIs would be well advised to create a policy that articulates how MRIs can be thoughtfully carried out to achieve the desired investment and social objectives.

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What is a PRI?
A PRI is a type of investment made by a private foundation with the primary goal of accomplishing its charitable mission.  It can take many forms, including equity, debt or a loan guarantee.  PRIs were codified as part of the US Tax Reform Act of 1969. This landmark legislation changed the regulatory landscape for private foundations in many ways.  Under the terms of the Act, certain excise taxes are imposed on private foundations for making “jeopardizing investments”, which are investments that jeopardize the foundation’s ability to carry out of its exempt purposes. However, the Act specifically carved out PRIs as an exception to the jeopardizing investment rules.

PRIs are treated more favorably than other types of foundation investments.  Unlike non-PRI investments, PRIs count toward the private foundation’s annual requirement to distribute, for charitable purposes, an amount equal to 5% of the fair market value of its assets,  other than those which are used (or held for use) directly in carrying out a foundation’s exempt purpose (known as the annual minimum distribution requirement).  This treatment reflects the view that PRIs are more akin to grants as they are motivated by the goal of accomplishing the foundation’s mission without regard to their return on investment.

Foundation managers looking to expand their impact may find that PRIs offer significant advantages over traditional grant-making. For example, grants are not repaid, whereas PRIs allow private foundations to make an impact, while generating some degree of financial return that can be recycled for use in a future grant or investment, thereby deepening the foundation’s impact. Traditional grants are also generally limited to charitable grantees (e.g., public charities), whereas PRIs can be issued to any entity pursuing a project that aligns with the foundation’s mission, including for-profit companies.

How do PRIs work?
To better understand how a PRI works, consider this hypothetical:
X is a private foundation with the mission of creating better living conditions for those living in poverty.  X decides to make a $1 million loan to Y, an organization that builds affordable housing for those living below the poverty line in the city of Z.  The loan is made at a below market rate, meaning that X could receive a better interest rate if it invested the funds somewhere else at a market rate.    X is making the loan for the reason that the loan furthers its mission.  As a result of the loan made by X, other investors begin to make loans to Y as well.  As a result, Y is able to build thousands of affordable homes for individuals living in Z.  Eventually, Y repays the loan to X.  Because of the repayment, X is able to use those resources again to make other investments or grants that advance its mission.  The funds are recycled for future use.

How does an investment qualify as a PRI?
To qualify as a PRI, an investment must meet a three-pronged test:

• The primary purpose of the investment must be to further one or more exempt purposes of the foundation;
• The production of income or the appreciation of property may not be a significant purpose of the investment; and
• The PRI cannot be used to fund electioneering or lobbying activity.

The first two prongs of the test warrant further examination.  The first prong, commonly known as the “primary exempt purpose test,” is subjective in that it is specific to each foundation.  It is actually a two-part test.  First, the investment being considered must significantly further the foundation’s exempt activities.  Second, the contemplated investment must be such that the foundation would not make it but for its relationship to the foundation’s exempt purposes.

The second prong of the test states that the production of income or the appreciation of property cannot be a significant purpose of the investment.  This test is more difficult to prove and often generates some degree of confusion.  After all, it is not always easy to determine that return was not a significant motivator is making an investment.  The easiest example of an instrument that would pass this test would be a below-market loan to an organization.  However, PRIs are not limited to loans.  As the Internal Revenue Service and Treasury Department has indicated in previously issued guidance, there are a number of forms a PRI can take, including equity investments, and loan guarantees.  In the final regulations issued by the IRS regarding PRIs, a common element to all of the examples included is that they all have the ability to generate some degree of financial return.  The use of PRIs can be a very effective way of deploying philanthropic capital.

Who uses PRIs?
With all of the benefits of engaging in a PRI, it’s surprising to learn that many private foundations do not use PRIs.  In fact, according the National Center for Family Philanthropy, as of 2017, less than 2% of the country’s more than 87,000 foundations use PRIs.  The larger players in the philanthropic world use them regularly.  For example, the Ford Foundation, a widely recognized trailblazer in the sector, has established a $200 million dollar pool of resources within its endowment for use as capital for PRIs.  On an annual basis, it awards nearly $17 million in PRIs.  In 2020, the Gates Foundation allocated in excess of $10 million to PRIs. The largest foundations avail themselves of this strategic philanthropic tool regularly. But what about the others?  When PRIs are used in concert with more traditional means of philanthropy, it can lead to a more powerful strategy with greater impact.

If a private foundation determines that deploying capital through a PRI should be a priority, the foundation may need to allocate resources toward building a team with the financial and legal knowledge to engage in a PRI strategy.  Effecting a program-related investment requires a fairly significant level of due diligence in order to ensure that the criteria are fully met, and include expenditure responsibility oversight requirements similar to that required of certain foundation grants. In some instances, the use of third-party advisors may prove critical to an effective PRI strategy.  Given the potential for PRIs to have a multiplier effect on social impact, foundation board members and management who have not yet delved into the world of PRIs should consider evaluating whether impact investing through PRIs would enhance programmatic success.

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