The NextWave Greentech Investing conference is coming up soon -- September 12th. And the crowd that's already registered is a nicely diverse mix of types of investors (LPs, VCs, corporates, family offices, etc.), in addition to entrepreneurs and others. One type of potential "investor" that doesn't get talked about as much, however, are the philanthropists who've traditionally played a small but important role in backing innovation, particularly in this sector.
Sarah Kearney (who'll be speaking at NextWave) thinks they can serve a much bigger role. She serves as the Executive Director of PRIME, a nonprofit that encourages philanthropic efforts in the energy sector. I asked Sarah to share some thoughts on what the role can be for philanthropy, and in particular "Program-Related Investments" (PRIs), which have been getting a lot of attention lately.
1. What are PRIs?
PRIs are a type of grant that can take the form of equity, loan or loan guarantee to for-profit companies – a way for grantmakers to get a tax deduction, make an impact, and get their money back to grant again in the future. PRIs have been around since the 1960s, but unfortunately have been used infrequently across charitable sectors and have almost never gone to energy-related causes. However, they could hold enormous promise for filling financing gaps in energy efficiency, innovation, and deployment – grantmakers are becoming increasingly interested in “impact investing.” Here’s how PRIs work:
Foundations -- pools of capital that receive tax exemption -- can be formed by corporations, families, or communities. These groups receive tax exempt status because they promise to do charitable things -- the IRS is the agency that holds them to that promise. To be specific, foundations have to give away 5% of their assets each year to “charitable purposes,” which the IRS defines as:
• Fostering amateur sports competition
• Preventing cruelty to children or animal
• Environmental conservation
o Relief of the poor
o Advancement of religion
o Advancement of science or education
o Lessening the burdens of government
o Lessening neighborhood tensions
o Eliminating prejudice and discrimination
o Defending human rights
o Combating community deterioration and juvenile delinquency
As examples, the Walmart Foundation gave away over $175M in 2012, the Gates Foundation gave away over $3B in 2011, and the Silicon Valley Community Foundation gave away almost $175M in 2011.
There is a strict set of rules that governs what these foundations can do with the money they do NOT give away every year (their endowment or corpus), including no “jeopardizing investments” – in other words, they can’t do risky stuff with 95% of their money because they would be putting the “charitable purpose” of the assets at risk.
On the 5% side, most foundations grant money to public charities (501c3 organizations), to make an impact and comply with the 5% minimum expenditure requirement. But they could grant that money as PRIs and get it back to grant again and again! The jeopardizing investment rules do not apply because Program-Related Investments are grants – money already intended to be given away for impact, specifically designed to be jeopardizing.
Unfortunately, less than .01% of total grantmaking the United States went to energy innovation in 2011 and less than .01% of PRIs made between 1998 and 2011 went to anything related to energy.
Why is this important? There’s $600B that sit in U.S.-based foundations. We’re observing venture capital funds and LPs fleeing from early-stage cleantech. And we desperately need patient capital to step in and support the type of technology innovation that can scale our world to 10 billion people. Our conclusion? PRIs are an unexplored solution to fill this gap.
2. What are examples of gaps that PRI capital could fill in the energy sector?
There are many ways PRIs could make an impact on our energy sector; it is capital that has a very long-term view (intergenerational impact!), high tolerance for risk (it’s a grant!), and company-building capacity. It can do things no other capital source can do - venture capital can’t accept opportunities that take longer than 10 years, long-term investors in instruments like municipal bonds can’t take high risk, and governments can’t invest in companies for fear of “picking winners.”
Here are a few examples of groundbreaking PRIs in the energy sector:
- DBL Ventures, based in San Francisco, recruited PRI makers as early LPs. DBL only makes investments into companies with positive social, environmental, and economic impact in local communities.
- The Clean Energy Trust, a nonprofit dedicated to accelerating clean-energy businesses in the Midwest, is constructing a fund that will live inside the public charity to invest in its own accelerator program’s companies. This fund is ripe for PRI investment; the charitability argument is strong for both environmental conservation and regional economic development.
- PRIME, my nonprofit effort, is constructing a fund thesis that could support transformational energy companies that may take longer than a traditional 10-year venture fund cycle. Imagine a PRI-backed ARPA-E commercialization fund.
- Next Step Living, a Boston-based residential energy efficiency company, recently added the RISC Foundation as a PRI investor to its Series C. The foundation is helping Next Step Living bring jobs and energy efficiency to New Haven, Connecticut.
3. What are the policy and human resource barriers that currently prevent more PRI-makers from entering the energy space?
I would group barriers into two categories: 1) policy barriers and 2) human resource barriers. Here’s what’s currently preventing PRI making in energy:
Energy is not a charitable purpose per se in Tax Code 501c3 language. Although existing charitable purposes such as environmental conservation, lessening the burdens of government, or economic development often apply to investment opportunities in energy, foundation representatives are largely uncertain if energy PRI opportunities do or should qualify as charitable. Here are their current choices:
- Avoid creative energy PRIs altogether (the easy way out)
- Pay expensive fees for legal opinion to quell uncertainty (very few lawyers have PRI experience)
- Go for it and risk excise taxes as penalty (very few foundations are testing the boundaries)
- Apply for a private letter ruling on a case by case basis (expensive and lengthy process, not practical)
Our field could benefit from more clarity around what, exactly, should be considered charitable in the energy space.
Human resource barriers
Within foundations, there are quite a few people-related barriers that are the most insurmountable part of increasing PRI making in energy:
- No champions
With very few exceptions, there is no institutional home for PRI-making inside most foundations, leaving us with no internal advocate arguing for PRIs versus other grant options.
- No experts
There are no energy investment experts embedded in private foundations’ grantmaking staff, so there’s no process for deal sourcing, due diligence, structuring of terms, value-added board membership, etc.
- No point of contact
For a variety of reasons, potential PRI-makers are inaccessible to PRI-seekers. If I’m an early-stage entrepreneur, I have no idea how to learn about the rules that govern private foundations, how to get in the door, pitch my business, or argue for the opportunity as PRI-qualified.
- No existence proofs
Very few PRIs have been made to the energy sector. This limits PRI makers and PRI seekers in forging ahead with new transactions because there is so much uncertainty around what is allowed.
On September 12th, Sarah will be talking about why she's optimistic that the pieces are coming together for PRI makers to step up and bring a significant new source of capital to the table to support greentech innovation. I'm a big fan of her efforts with PRIME and am looking forward to hearing more about what progress she's seeing out there in the sector. As the barriers Sarah mentions are overcome, there's a lot of capital sitting on the sidelines that can and should be put to good use here.