Impact Investing Requires Foundations to Think and Act in New Ways

The Greater Tacoma Community Foundation decided 18 months ago to allocate some of its assets to impact investing—a strategy that aims to generate a social as well as a financial return.

Impact investing is spreading widely in the nonprofit world, including to an increasing number of community foundations like Greater Tacoma. The foundations are primarily making low-interest loans to both charities and socially conscious for-profit companies.

The loans are assisting community health centers as they prepare to serve more patients under the Affordable Care Act, helping food companies open stores in areas declared “food deserts,” and renovating or building low-cost housing in urban areas. Some grant makers, including the Kresge Foundation and the Oregon Community Foundation, are going a step further by making equity investments in companies whose business plans match up well with their mission.

The best part, say foundation officials, is that in addition to doing good, they are likely to get their money back, often with some sort of return.

“You make a grant and it’s gone,” says Jeffrey Pritchard, director of philanthropic services at Greater Tacoma. “The big potential with impact investing is you can recycle your money.”

More Complicated

But impact investing is in many ways more complicated than grant making. It can require cooperation among program offers and investment managers—two sides of the foundation that often operate in silos. Foundation boards have a tough time evaluating the effectiveness of impact investing. Among their questions: How much “social return” do you need to compensate for a lower financial return?

And as Mr. Pritchard found out, there’s more paperwork involved when a foundation hands over funds that it eventually expects to get back.

Greater Tacoma had planned to handle its own impact investments when the board approved putting 3 percent of its $92-million in assets into the strategy. But that idea was quickly shelved when Mr. Pritchard met with a local charity that had received a loan from another provider and saw all the documentation required.

“The light went on that we were getting in over our heads,” he says. “I think most community foundations are going to find that they just don’t have the bandwidth or the expertise to do this internally.”

The complexity of impact investing is giving rise to new consultants, such as Imprint Capital, in San Francisco, which creates and manages customized impact-investment programs, and Third Sector Capital Partners, in Boston, which helps to construct social-impact bonds and other “pay for performance” structures.

The Maine Community Foundation announced in August that it would start its first impact-investment program with the help of the Nonprofit Finance Fund and the Good Analyst, which develops tools to measure the social impact of investment decisions.

Greater Tacoma ultimately decided to work through community-development financial groups, which have decades of experience lending money to nonprofits and companies in low-income areas. The community foundation’s two loan programs with CDFIs total about $1.5-million, and the money ultimately goes to small businesses and charities in the Tacoma area.

Only about half of the $3-million that Greater Tacoma has allocated to the strategy has been placed with the two financial institutions. Mr. Pritchard says the desire by foundations to make impact investments may be outstripping the current demand for loans or capital from nonprofits and socially oriented businesses.

“It s not like you can turn on a switch and find great opportunities,” he says.

No Applications

During the recession, the Colorado Health Foundation created a low-interest loan fund to help the state’s community health centers survive, but it was surprised to receive no applications. The foundation, sensing that the nonprofit health centers didn’t want to share their need for a loan with a foundation from which they might also seek a grant, made a $3-million grant to the Colorado Community Health Network so that it could operate a similar loan fund.

But that fund has been slow to get off the ground. Only two loans, totaling $800,000, are outstanding. Officials at the health network expect demand for its flat-rate 3-percent loans to pick up when bank interest rates tick higher. They also expect the health centers to borrow to add space and staff when the 2014 expansion of Medicaid leads to more patients and higher federal reimbursement rates.

For now, says Kelly Dunkin, the Colorado Health Foundation’s vice president for philanthropy, many of the state’s community health centers look at the foundation’s $2.2-billion endowment and dream of grants, not loans.

“People are smart,” Ms. Dunkin says. “Free money is always more attractive than even a low interest-rate loan.”

State Support

One of the most-talked-about trends in impact investing is social-impact bonds, in which investors provide the upfront money to achieve a social good and the government pays back the funds along with a return if the investment saves the government money.

The concept was pioneered more than three years ago in the United Kingdom, and there are currently a handful of experiments in the United States, including pilot projects in New York, Massachusetts, and Utah.

In Utah, Goldman Sachs and the J.B. and M.K. Pritzker Family Foundation have agreed to invest as much as $7-million to deliver high-impact preschool programs to more children. The goal is to expand a Utah program that has already shown that it saves the state money by getting more children ready for kindergarten and keeping them out of expensive special-education and remedial services.

But the state’s legislature voted down a bill that would have enabled payments to the investors if the program saved the state money. Salt Lake County, which hopes the effort will ultimately save it money on juvenile-justice programs, committed $350,000 to the project but only after the United Way of Salt Lake committed $1.1-million to pay back investors and prove that the social-impact bond works.

“We’re confident that the public sector—not only in our state but in others—will eventually see the value in this,” says Bill Crim, the United Way’s senior vice president for community impact and public policy.

Other Ideas

As social-impact bonds struggle to gain a footing, some foundations are experimenting with other pay-for-performance investments. Kresge has developed several financial structures, says Kimberlee Cornett, the foundation’s director of social-investment practice, including reducing the interest rate on a loan if the charity is able to meet operating goals that both it and the foundation have agreed upon.

The Colorado Coalition for the Homeless, which provides health care to people who lack permanent housing, raised money for a new $35-million building that can better handle the expected spike in patients after the expansion of Medicaid. But the coalition also needed additional money upfront to train new staff members and improve its data systems.

Kresge met that need by giving the charity a $3-million loan at a 4-percent interest rate. Kresge also agreed to drop the rate to just 1 percent if the coalition hits various goals tied to larger patient volumes, improved patient health, and reduced emergency-room costs.

“We’ll have to be focused to make it work,” says John Parvensky, the coalition’s president. “One of the side benefits of an arrangement like this is that it focuses one’s attention on these particular metrics and outcomes.”

‘Healthy Skepticism’

Fueling the growth of impact investing are reports suggesting that foundations can expect high rates of repayment on the loans they make. But that doesn’t take into account the fact that the goal of such loans is typically to help charities and socially conscious businesses that might be rejected by banks for such borrowing—or charged exorbitant interest rates—so by definition the loans are riskier. Mr. Pritchard, of the Greater Tacoma Community Foundation, says newcomers to impact investing should be wary of reports about 100-percent repayment rates.

Mr. Pritchard, who spent 25 years in investment management at Wells Fargo, notes that some foundations have taken extraordinary measures to avoid messy defaults. “Going into this with some healthy skepticism is the smartest thing that you can do,” he says.

The experience of the Grand Rapids Community Foundation illustrates his point.

In 2006, during the height of the real-estate bubble, the community fund agreed to make a $462,000 loan to the Dwelling Place, a local nonprofit that focuses on low-cost housing. The money was used to purchase real estate in a depressed area, with a plan to redevelop the nine properties and turn them into permanent low-cost housing. But the value of the properties plummeted during the financial crisis, and Dwelling Place turned the project over to Kent County Habitat for Humanity in 2008.

The community fund was eventually repaid in full, says Laurie Craft, a program director, but she acknowledges that the financial return on the investment could hardly be described as a success.

The community foundation had to make a grant worth $150,000 to the Dwelling Place to enable the charity to make improvements to the properties so that Habitat For Humanity would be willing to step in, she says.

“We didn’t envision the grant at the time that the loan was made,” Ms. Craft says.

Even so, the community foundation remains committed to impact investing. In January, its board committed 2 percent of its $250-million endowment to such investments.

Since 2012, the community foundation has made loans worth $1-million, at a 3-percent interest rate, to the Kent County Land Bank Authority, which has enabled the land bank to acquire all 160 foreclosed properties in Grand Rapids. The land bank brings the properties up to code and then tries to sell them to people who will live there or to responsible landlords, to shut out investors who would flip the properties without making improvements.

The land bank is already making good progress selling the improved properties. Ms. Craft says she doesn’t foresee any of the hiccups that plagued its last housing loan: “We should get this one back.”