Getting Your Feet Wet Three Approaches
The best way to learn to make PRIs is by doing it. As the executive director of one new PRI-making foundation put it, "It comes from experience, and the only way you can get experience is to make some investments." PRI makers seem to have gotten into the PRI pond in one of three ways: they jumped in, they waded in, or they were thrown in by circumstance.
Jumping In: Building PRIs into Overall Strategy
Some PRI makers set out with the express goal of integrating PRIs into their foundation’s overall strategy - a big commitment that may emerge from a strategic planning process or the arrival of a new chief executive. Most foundations in this cohort enjoyed strong board support for PRIs and understood clearly how PRIs would fit into their overall mission.
Not long ago, for example, a family foundation began looking at PRIs as a way to extend its long-standing commitment to fighting poverty in low-income communities. For over a decade, the foundation had focused on building leadership and capacity among the small, grassroots organizations in its grant-making portfolio. After making a few grants to help organizations develop revenue-generating enterprises, program staff began to wonder if PRIs might help them build up their credit histories and business skills. At that point, grantmakers reasoned, the organizations would have access to more capital than the foundation could provide with grants alone.
The board gave its enthusiastic go-ahead to pursue PRIs, but there was one major obstacle: no one on the program staff had any investment experience. "We were pretty gun shy about our own capacity to make PRIs directly," the executive director recalled.
The foundation decided to build its internal capacity by co-investing with a more experienced investor that was willing to act as a mentor. The veteran PRI maker shared due diligence with the novice foundation, acting as a technical advisor and consultant on a $500,000 investment in a community-oriented venture capital firm. Staff members from the two foundations spent several days together reviewing internal systems, investment analysis, skill-sets, and how various job functions - program, administration, and investment - need to be aligned to make sound investments.
As the novice foundation develops its PRI program, it will focus on its core geographic region. In the meantime, the two foundations are exploring other investments. "It's great to have the Cadillac version," said the executive director regarding the experienced foundation’s due diligence. "As we learn what we're looking for, we can take more calculated risks."
Wading In: Taking It One Deal at a Time
Other foundations have moved more cautiously, withholding the decision to pursue a PRI strategy until they have made one or two pilot investments. Even the most supportive board members may need to be convinced, and a go-slow approach can be a good way to demonstrate the effectiveness of PRIs without making major commitments of effort and capital. Several small foundations stood waist-deep for years, setting up a series of ad hoc investment teams that seized opportunities as they arose from the foundation's regular grantmaking. Other foundations co-invested with other PRI makers but didn't make a deliberate effort to learn the ropes.
The chief operating officer of a foundation on the West Coast described his organization's initial foray into PRIs. Founded in 2002, the foundation has focused mainly on getting its grantmaking operations up and running, but the board also approved a $6 million PRI budget. Instead of staffing up immediately, the foundation hired a consultant to coordinate due diligence and manage the contract negotiations for its initial program-related investments. In 2004, the foundation made its first PRI as a private equity investment in a well-regarded intermediary that provides capital or small businesses and microenterprises in developing countries.
Like the organization that dove in, this foundation found an experienced foundation partner that had already invested in the intermediary. The experienced foundation shared due diligence, business modeling, and legal opinions, but the partnership didn't have a strong mentoring quality. "It was sort of like having a lead investor," the COO of the novice foundation recalled. "This was a blue-chip fund we were supporting, but having a co-investor gave us more confidence."
Following the success of that first investment, the foundation is ramping up slowly, selectively favoring a PRI structure when it appears to work better than a grant. The PRI consultant was recently hired as a fulltime employee, and he has begun to develop legal and due diligence capacities - yet, for now, the foundation is still taking it one deal at a time. "I don't know how far it's going to go," the COO said, noting that the foundation doesn't plan to add more staff members to its nascent PRI unit.
Developing internal policies will be part of the work, the COO acknowledged: "What do we do if a grantee defaults on a loan? If we're serious about getting paid back, what expertise and resources do we need to have on hand to restructure a deal? Those are decisions we need to make down the road."
Thrown In: Making a PRI to Support Core Grantmaking
From time to time, a foundation finds itself making a PRI because it's the best way - or the only way - to support a longtime grantee or program objective. Investments like this tend to have a good-news / bad-news quality. On one hand, because the investment emerges from a core grantmaking area, the foundation knows the field and the players in it. On the other hand, because the proposed investment is thrust urgently upon it, the foundation must scramble to structure a one-time deal. Many times, these are investments foundations can't afford not to make.
For example, a community foundation in the Northeast had long been a supporter of its state's pioneering effort to provide health care for low-income families. In 1994, the foundation made a planning grant to one of four health plans that would provide eligible uninsured children, families, and pregnant women with comprehensive health care under the state's Medicaid program. Within six years, the plan's community health centers were providing care to more than half of all Medicaid enrollees in the state. It was a crucial resource for poor and minority families.
In 2000, the health plan's preferred shareholder, an out-of-state, for-profit company, announced that it wanted to liquidate its holdings, a move that could have imperiled health care access for the plan's low-income members. "We realized that some entity could come in, buy [the health plan], and decide they don't want the Medicaid population - and there wouldn't really be anything anyone could do about that," said the foundation's senior vice president. "The whole Medicaid managed care system that we had developed would be shattered."
Instead, the foundation made a $4 million PRI that allowed the health plan to buy out its shareholders and convert to nonprofit status. The foundation purchased the for-profit company's shares and converted its equity stake into a 20-year bond at 5.75 percent.
Although the health plan was in good financial condition and its executive leadership and operations were strong, the investment still carried risks. The plan relies heavily on federal Medicaid funding - a significant factor in an era of state budget deficits and privatization. Recognizing the role of the health plan in the state's health care system, the state agreed to a risk-sharing agreement that provides $2 million per year as operational revenue above and beyond Medicaid payments for members.
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This takeaway was derived from Program-Related Investing.