Blueprint Research & Design

In the last post, we alluded to the many benefits of PRIs that have been written about since the PRI was formally established as a philanthropic tool in 1969. These include:

• helping investees retain a commitment to mission
• becoming better grantmakers
• extending the foundation’s resources
• capacity-building for individuals and institutions; catalyzing or strengthening good management within recipient organizations
• enabling nonprofit organizations to build long-term assets
• obtaining project or venture financing
• increasing impact and sustainability
• increasing activity and meeting goals for both mission impact and financial self-sufficiency
• proving a market or the creditworthiness of an institution; helping prove creditworthiness
• gaining discipline and efficiency through intensified financial analysis and accountability
• leveraging and bridging to capital markets; providing a bridge to mission-related investing
• lending to new entrepreneurs or homeowners who lack access to traditional capital markets
• filling financing gaps for projects requiring subsidies due to modest revenue streams, high transaction costs, or other limitations
• allowing commercial lenders to participate in large deals by taking higher-risk positions
• establishing track records for pilot programs or new financial products to help move program to scale
• leveraging other capital from conventional sources by taking on real or perceived higher risk
• strengthening recipients by fostering long-term sustainability and improving cash flow
• offering flexibility to make larger distributions or increase payouts during rapid foundation growth

For grantmakers who only provide grants, some of these benefits might sound familiar. Indeed, grants are often used to build nonprofit capacity, obtain project financing, and strengthen recipients by fostering long-term sustainability and improving cash flow. Even objectives like gaining discipline and efficiency through intensified financial analysis and accountability can fall under the umbrella of venture philanthropy, while still using grants. Thus, the real challenge for those who believe PRIs should be more widely adopted by foundations isn’t around understanding how PRIs generate impact, but how they generate additional impact compared to the common counterfactual – for example, what would have happened if the foundation provided a grant instead.

For illustrative purposes, let us assume there is a nonprofit that requires $1 million in capital to engage in a particular activity that will start generating revenue in the second year (at this point, let us assume the activity doesn’t matter – we’ll examine the tradeoffs between PRIs and grants for specific activities later). Let us also assume that a foundation is willing to provide the $1 million in capital the nonprofit needs, as either a grant or a PRI. If we assume that the performance of the nonprofit will not vary based on the type of capital it receives, what differences in impact could we expect from a funder providing a PRI instead of a grant?

In this extremely simplified scenario, a quick mental calculation using BACO analysis reveals that in the first year there is no immediate tradeoff between a PRI and a grant; the nonprofit receives $1 million from either to engage in whatever activity it needs the funds for, whether it’s purchasing a building, investing in equipment, or providing microfinance loans. Since we assumed that the performance of the nonprofit will not vary based on the type of capital it receives, the social impact and subsequently the BACO ratio for the grant and PRI in the first year are the same.

The difference in social impact potentially comes in the second and subsequent years. The PRI and the grant, like in the first year, have the same costs, which in the second year is nothing since the foundation only provides capital in the first year. However, the social impact projections will be different based on how capital is allocated. In the case of a PRI, the nonprofit repays the foundation which could then use the funds to provide more loans or grants. In the case of a grant, the nonprofit would not repay the foundation but use the money instead on its own programs. In theory, if a foundation provided a PRI and used the repayments to provide the PRI recipient additional grants, there would be virtually no difference between the foundation providing a PRI or a grant. But by providing a PRI, the foundation is able to have more precise control over its grantmaking and potentially better allocate philanthropic capital by giving the foundation the option of providing a large amount of capital to one organization and the ability to use loan repayments to fund several other organizations in the future.

The previous example proves a very basic point – that when a foundation makes a PRI instead of a grant for the same activity, it has more control over how future dollars are spent. However, it also underscores the fact that when a PRI and a grant fund the same activity, the benefit of recycling funds to the foundation may be overstated. Although a grant does not recycle funds back to the foundation, when it funds the same activity as a PRI, the dollars are still recycled – just back to the nonprofit. A classic illustration of this would be Kiva – providing a grant or a loan enables Kiva to provide loans to microfinance institutions, where choosing one financial instrument over the other simply changes who has ultimate control over the funds provided in the future. Thus, when considering the use of PRIs versus a grant, it is more accurate to say that a PRI provides the foundation more control on how recycled funds are spent rather than to say that PRIs recycle more funds or generate more dollars than a grant would.

Another point to consider, though not applicable to every foundation especially those who practice unconstrained philanthropy,  is that some foundations place ceilings on grant funds. A foundation may choose to place an arbitrary limit on the size of a grant, which is usually less than the limit placed on PRIs. Thus, when conducting a BACO analysis to compare a grant and a PRI, the comparison is not between a $1 million grant and a $1 million PRI, but 10 $100k grants to different organizations and a $1 million PRI. For example, when the Studio Museum in Harlem, at the time America’s only accredited black fine arts museum, approached the Ford Foundation for a grant to finance the renovations for a building it had recently secured, its grant request would have been most likely turned down. But the Ford Foundation was willing to make a PRI to provide Studio Museum the capital it needed. For nonprofits that are looking to secure a large amount of funding immediately, whether it’s to invest in an earned income venture or secure property, grant funding will often not provide the total amount of capital the organization needs; a $100,000 grant may not provide the financing it needs for expansion, but instead may only fund incremental improvements to its program. Thus, for foundations who have limits on grant sizes and are comfortable making larger PRIs, a large PRI may be preferable to providing a set of smaller grants when a nonprofit has sizable upfront capital needs.

To illustrate the fundamental difference between PRIs and grants, which by definition would be the expectation of repayment, we assumed that ceteris paribus, the major difference between the two financial instruments is really in how future philanthropic capital is allocated. In the subsequent posts on financing an earned income venture, leveraging government dollars, and supporting fundraising and capacity building, we relax some of these assumptions to look at how providing a PRI or a grant may actually result in different behaviors in nonprofits that ultimately affect impact.