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.

The post Are You Looking to Make an Impact? Consider a Program Related Investment first appeared on Perlman Sandbox.

The Benefit Corporation

Thanks to relatively recent legislation in a number of jurisdictions, social entrepreneurs have the option of incorporating as a benefit corporation or public benefit corporation as it is known in Delaware.  Benefit corporation laws actually require a corporation to pursue a mission and to take that mission into account when conducting business.  Most jurisdictions require that the benefit corporation report to its shareholders about how it has been pursuing its mission, and some states require that report be made publicly available.  The benefit corporation does give its officers and directors a certain amount of protection when pursuing a company’s mission.  The officers and directors have the ability to focus on mission in addition to maximizing shareholder value.  However, the benefit corporation is a fairly new concept and is only now being broadly tested in the capital markets.  The recent initial public offering by Laureate Education is a prominent test case.  It is still too early to tell how the investing public will react to this new corporate entity.  It is also worth noting that Laureate Education may not be the best test case, since it has the advantage of being able to rely on the resources and network of its financial sponsors, which include private equity behemoths. Not all benefit corporations seeking to become public companies will have the backing of private equity sponsors.

Incorporating as a benefit corporation is one avenue of trying to enshrine social mission into a company’s DNA. But a close reading of these statutes reveals that they don’t actually require much. “Social purpose” is defined very broadly and is vague. And directors can fulfill their obligation by considering the social mission when making business decisions: they don’t actually have to do anything differently than they would if they were solely seeking profit. Finally, of course, is the fact that in certain jurisdictions a company can simply opt-out of the Benefit corporation designation with no consequences.

There are other alternatives available to the social entrepreneur to make social purpose intrinsic to the corporate structure without having to change a company’s corporate form.  Below we will discuss some of these methods:

Charters, Bylaws and Shareholder Agreements

One way to safeguard a social mission is to include mission related provisions in the organizational documents of a company – even a “regular” corporation or LLC.  The charter of a corporation can be drafted to contain provisions that authorize or require the organization to comply with a social mission.  A company’s bylaws can require its officers and directors to take social missions into account when performing their duties, just as they would be required to do with a benefit corporation.  For example, the bylaws of the company might authorize the directors and officers of a company that manufactures environmentally friendly products to take into account the environmental practices of their suppliers in addition to more traditional metrics like cost.

Shareholder agreements can also be used to embed mission.  A well-crafted shareholder’s agreement – essentially a contract between the corporation and the shareholders – can require the company to pursue a social mission in the course of carrying on its business, and prevent shareholders from trying to inhibit the pursuit of social objectives.  For example, shareholders agreements can be drafted to require a supermajority in order to alter provisions relating to a company’s mission, or to give non-consenting shareholders the right to sell their stock back to the company if the social mission is diminished.  Shareholder agreements can also mandate specific mission-related reporting to shareholders, and give the shareholders rights of inspection that they would not otherwise have.  Although, shareholder agreements can be amended over time, steps can be taken to make it harder to amend or remove provisions that relate to social purpose.

Capital Structure – Classes of Stock

For-profit corporations can also protect a social mission through the design of its capital structure.   For example, socially minded corporations can create multiple classes of stock that allow one class of shareholders (call it Class A) to receive one vote per share while shareholders in the other class (Class B) get several votes per share. In a common scenario, Class A stock will be held by the investors, and Class B stock will be held by the founder or others (including foundations) who give priority to the social mission and can use their voting power to protect the mission. A company can also issue a class of preferred stock that grants its holders certain rights that are different from those of common stock holders.  Those rights could include the ability to veto any policies or practices that would impair or diminish the company’s commitment to a social mission, including mission related provisions in a shareholders agreement (see above.)  In a slight variation of this approach, some social entrepreneurs have granted preferred stock to non-profit foundations.  Those foundations are able to take the company’s mission into account when exercising their rights as holders of preferred stock.

Third Party Certification

For brand focused industries, getting certified by a credible organization that develops certain standards for its members in areas such as worker impact, environmental impact or community impact can distinguish a business in a market place that is crowded with competitors all claiming to be “good” companies.  If a company is certified by such an organization, it has to maintain its standards in order to be re-certified. While being certified by such an organization does not necessarily embed mission into a company’s corporate structure, the possibility of not being recertified does make it harder to dilute any social or environmental values.  Some of these certifying organizations actually require companies to alter their governing documents in order to ensure that a corporation’s social values will endure changes in management, etc.  Many also argue that having this type of third party certification can help a social entrepreneur attract mission-driven or impact investors.  B Corp certification is an example of this type of third party certification.  Some well-known companies that use the B Corp certification include outdoor apparel manufacturer Patagonia and home products manufacturer Seventh Generation.  Other examples of third party certification include the Green Seal certification which is available to manufacturers of environmentally responsible products.  The Green Seal certification on a product helps purchasers identify products that are safer for the environment.  These are only two examples; there are numerous other standards that can be used as well.

Creative Alternatives for Safeguarding Mission

These are just the commonly used solutions to safeguarding mission.  There are other creative ways of requiring a company to adhere to its mission.  For example, lenders who are interested in social enterprise could insist on a maintenance covenant that requires the borrower to pursue its mission and provide the lender with certain quarterly metrics. Other options include restrictive provisions in long-term IP licenses, joint venture agreements, and other agreements that bind a company, make it accountable to outside interests, and are legally enforceable.

If creating enforceable legal obligations with respect to mission is important, there are a lot of tools available to the social entrepreneur or a group of investors to accomplish this.  It’s up to the company’s founders, officers and directors to pick the strategy that best fits their needs.  Sometimes one technique alone will not suffice, and a combination will be used. Experienced and knowledgeable advisors are a good place to start.

The post Incorporating Social Mission: Options for Social Entrepreneurs first appeared on Perlman Sandbox.

Business with a purpose, triple bottom line, social enterprise, for-purpose business, social venture  

In this day and age, the mainstream consumer is increasingly socially conscious, thus an organization’s social mission is ever more vital. To meet the expectations of a value-driven culture,  companies with mission must securely protect it despite their fiduciary duty to investors.  Familiar brands which have managed to navigate the early waters of this territory include Whole Foods, Starbucks, Ben & Jerry’s, Tom’s, Etsy and Warby Parker. Below I outline options for these social enterprises, and others, to embed mission into their legal structures so they may  stand firmly behind their values while simultaneously managing the bottom line.

The Benefit Corporation

Thanks to relatively recent legislation in a number of jurisdictions, social entrepreneurs have the option of incorporating as a benefit corporation or public benefit corporation as it is known in Delaware.  Benefit corporation laws actually require a corporation to pursue a mission and to take that mission into account when conducting business.  Most jurisdictions require that the benefit corporation report to its shareholders about how it has been pursuing its mission, and some states require that report be made publicly available.  The benefit corporation does give its officers and directors a certain amount of protection when pursuing a company’s mission.  The officers and directors have the ability to focus on mission in addition to maximizing shareholder value.  However, the benefit corporation is a fairly new concept and is only now being broadly tested in the capital markets.  The recent initial public offering by Laureate Education is a prominent test case.  It is still too early to tell how the investing public will react to this new corporate entity.  It is also worth noting that Laureate Education may not be the best test case, since it has the advantage of being able to rely on the resources and network of its financial sponsors, which include private equity behemoths. Not all benefit corporations seeking to become public companies will have the backing of private equity sponsors.

Incorporating as a benefit corporation is one avenue of trying to enshrine social mission into a company’s DNA. But a close reading of these statutes reveals that they don’t actually require much. “Social purpose” is defined very broadly and is vague. And directors can fulfill their obligation by considering the social mission when making business decisions: they don’t actually have to do anything differently than they would if they were solely seeking profit. Finally, of course, is the fact that in certain jurisdictions a company can simply opt-out of the Benefit corporation designation with no consequences.

There are other alternatives available to the social entrepreneur to make social purpose intrinsic to the corporate structure without having to change a company’s corporate form.  Below we will discuss some of these methods:

Charters, Bylaws and Shareholder Agreements

One way to safeguard a social mission is to include mission related provisions in the organizational documents of a company – even a “regular” corporation or LLC.  The charter of a corporation can be drafted to contain provisions that authorize or require the organization to comply with a social mission.  A company’s bylaws can require its officers and directors to take social missions into account when performing their duties, just as they would be required to do with a benefit corporation.  For example, the bylaws of the company might authorize the directors and officers of a company that manufactures environmentally friendly products to take into account the environmental practices of their suppliers in addition to more traditional metrics like cost.

Shareholder agreements can also be used to embed mission.  A well-crafted shareholder’s agreement – essentially a contract between the corporation and the shareholders – can require the company to pursue a social mission in the course of carrying on its business, and prevent shareholders from trying to inhibit the pursuit of social objectives.  For example, shareholders agreements can be drafted to require a supermajority in order to alter provisions relating to a company’s mission, or to give non-consenting shareholders the right to sell their stock back to the company if the social mission is diminished.  Shareholder agreements can also mandate specific mission-related reporting to shareholders, and give the shareholders rights of inspection that they would not otherwise have.  Although, shareholder agreements can be amended over time, steps can be taken to make it harder to amend or remove provisions that relate to social purpose.

Capital Structure – Classes of Stock

For-profit corporations can also protect a social mission through the design of its capital structure.   For example, socially minded corporations can create multiple classes of stock that allow one class of shareholders (call it Class A) to receive one vote per share while shareholders in the other class (Class B) get several votes per share. In a common scenario, Class A stock will be held by the investors, and Class B stock will be held by the founder or others (including foundations) who give priority to the social mission and can use their voting power to protect the mission. A company can also issue a class of preferred stock that grants its holders certain rights that are different from those of common stock holders.  Those rights could include the ability to veto any policies or practices that would impair or diminish the company’s commitment to a social mission, including mission related provisions in a shareholders agreement (see above.)  In a slight variation of this approach, some social entrepreneurs have granted preferred stock to non-profit foundations.  Those foundations are able to take the company’s mission into account when exercising their rights as holders of preferred stock.

Third Party Certification

For brand focused industries, getting certified by a credible organization that develops certain standards for its members in areas such as worker impact, environmental impact or community impact can distinguish a business in a market place that is crowded with competitors all claiming to be “good” companies.  If a company is certified by such an organization, it has to maintain its standards in order to be re-certified. While being certified by such an organization does not necessarily embed mission into a company’s corporate structure, the possibility of not being recertified does make it harder to dilute any social or environmental values.  Some of these certifying organizations actually require companies to alter their governing documents in order to ensure that a corporation’s social values will endure changes in management, etc.  Many also argue that having this type of third party certification can help a social entrepreneur attract mission-driven or impact investors.  B Corp certification is an example of this type of third party certification.  Some well-known companies that use the B Corp certification include outdoor apparel manufacturer Patagonia and home products manufacturer Seventh Generation.  Other examples of third party certification include the Green Seal certification which is available to manufacturers of environmentally responsible products.  The Green Seal certification on a product helps purchasers identify products that are safer for the environment.  These are only two examples; there are numerous other standards that can be used as well.

Creative Alternatives for Safeguarding Mission

These are just the commonly used solutions to safeguarding mission.  There are other creative ways of requiring a company to adhere to its mission.  For example, lenders who are interested in social enterprise could insist on a maintenance covenant that requires the borrower to pursue its mission and provide the lender with certain quarterly metrics. Other options include restrictive provisions in long-term IP licenses, joint venture agreements, and other agreements that bind a company, make it accountable to outside interests, and are legally enforceable.

If creating enforceable legal obligations with respect to mission is important, there are a lot of tools available to the social entrepreneur or a group of investors to accomplish this.  It’s up to the company’s founders, officers and directors to pick the strategy that best fits their needs.  Sometimes one technique alone will not suffice, and a combination will be used. Experienced and knowledgeable advisors are a good place to start.

The post Incorporating Social Mission – Options for Social Entrepreneurs first appeared on Perlman Sandbox.

The skeptics are now learning to never say never. Laureate Education Inc. has recently filed a registration with the United States Securities Exchange Commission for an initial public offering.  The company is a Delaware Public Benefit Corporation. Laureate is also a B Corporation, having completed the rigorous assessment and made the grade to certify as a B.

The corporation’s stated public benefit is to produce a positive effect (or a reduction of negative effects) for society and persons by offering diverse education programs online and on premises in the communities that they serve.  The initial public offering is being underwritten by some of Wall Street’s most prestigious names.  Even more striking is that Laureate Education is a portfolio company of KKR, the private equity behemoth. With KKR standing behind this IPO, there are bound to be many interested investors.

The underwriters as well as the company’s financial sponsors have taken the position that investing in a benefit corporation is, at the end of the day, no different from investing in a traditional corporation.  When the IPO closes, Laureate Education Inc. will likely become the first publicly traded public benefit corporation.  Once the first successful IPO of a benefit corporation occurs, who knows how many others will follow?  Perhaps the long-held proposition of the social entrepreneurship community that businesses can do well and do good at the same time will finally be fulfilled.

The post The First IPO of a Benefit Corporation – Will Laureate Turn the Tide? first appeared on Perlman Sandbox.