Peter Goldberg and John MacIntosh
June 9, 2021
In April, Cass Walker Harvey and Mike Roque wrote a helpful primer for NPQ that provided some background on program-related investment (PRI) loans and when and how they can make sense. As a lender and a borrower who have structured two distinct PRIs (one of which has been successfully repaid, though the other remains outstanding), we believe we can add to the conversation by providing some useful nuance and lessons learned.
We believe in the potential for PRIs to increase impact, both for nonprofits and for foundation lenders. At the same time, finding common ground is not always easy between a lender that wants to get its money back and a nonprofit that might have different interests in how to structure a loan—or be hesitant to take on debt at all. We’ve seen first-hand that debt can be dangerous. The phrase “Neither a borrower nor a lender be” resonates for a reason. However, there are moments when appropriately structured debt can help nonprofits achieve maximum impact. Here is our story of how a foundation-backed loan fund, the New York Pooled PRI Fund (NYPRI), managed by SeaChange Capital Partners, and a nonprofit borrower, the Brooklyn Community Bail Fund (BCBF), were able to advance their joint missions through a carefully structured PRI loan.
While its work has expanded significantly over time, BCBF was established in 2012 to free people who were in jail solely for their inability to pay bail and to advocate for the abolition of wealth-based detention. BCBF began paying bail to free defendants arrested for misdemeanors in April 2015, a few months before serendipity brought it together with NYPRI.
At BCBF, taking on debt was not initially considered an option, given it was a startup with a novice executive director operating without any hard assets and with a limited operating history in a new and controversial area. For these very reasons, the BCBF board would have been hesitant to take on debt.
At the same time, BCBF recognized its lack of access to capital was limiting its impact. Although fundraising was growing nicely, people were languishing in detention who could have been released, given additional funding. The organization also needed to ensure payroll for a small but growing staff, so a funding source separate and unconnected to its operating budget was attractive. In addition to the individual impact, more funding and more individuals freed would increase BCBF’s ability to press forward on its principal advocacy goals, as it and other bail-paying peers were quickly becoming too large to ignore.
Given this, BCBF and NYPRI began to explore whether a loan could be structured on mutually acceptable terms. Fortunately, none of the foundations in NYPRI were existing BCBF supporters so there was little risk of a loan cannibalizing funds that might otherwise have been available as grants. In fact, receiving a loan from NYPRI might be a good way to engage new funders.
In starting the exploration, one thing was clear: 100 percent of any loan would be used to pay bail and 100 percent of the returned bail payments would be used to repay the debt. But there were other thorny issues to explore: Could BCBF recycle the loan, since some bail repayments come back in a matter of months? How should BCBF address the inherent uncertainty surrounding the timing and amount of bail repayments? How could BCBF pay interest on the debt, given limited unrestricted funding? How could BCBF ensure that compliance with the loan terms would not adversely affect clients or compromise core values, including confidentiality?
After some trial and error, NYPRI and BCBF agreed on a structure:
- BCBF could “recycle” bail payments that returned to it for three years, after which the loan would be repaid from bail payments as and when they were received.
- The interest rate would be set at zero.
- The loan would be non-recourse other than a 20-percent “first-loss” position (funded up front), which would allow NYPRI to get all its money back so long as at least 80 percent of those released from detention attended their later court dates. (This protected both parties against the uncertainty of the repayments.)
- A NYPRI representative would join BCBF’s finance committee as an observer.
The deal was a compromise. NYPRI’s funders would have preferred an interest rate greater than zero. BCBF felt the 20-percent, first-loss position was too conservative. Both of us were a little nervous about the observer position because neither of us had done that before and we understood the potential conflicts. But we’d come to trust one another, so we mutually took the plunge.
In retrospect, the initial $700,000 loan was a game changer. It allowed BCBF to do more, faster than otherwise possible. Due to the loan, BCBF was able to free 5,000 people from pretrial detention. In fact, BCBF became the largest bail fund in the country, which allowed it to play a larger role in the movement to abolish the cash bail system in New York. The NYPRI loan also brought other investors to the table and was the template used when BCBF began paying immigration bonds to free individuals held in ICE (US Immigration and Customs Enforcement) detention. Again, loan funding has been crucial to this initiative—nearly two thirds of the $5 million paid to cover immigration bonds at BCBF has come in the form of PRIs, allowing BCBF to secure the freedom of nearly 600 people from ICE detention. Some of the relationships gained through the loan also led to additional grant support. The NYPRI representative on the finance committee has not created any conflicts and has brought useful perspective to organizational discussions over the years.
Lessons Learned and Some Key Nonprofit “Red Lines”
Ours is a story where everything worked out, but we are not suggesting PRIs are a suitable fit to address every nonprofit problem or need. Let’s be clear: in the vast majority of cases, nonprofits need grants more than anything else. And when they do need loans, conventional lenders can usually provide them. However, our experience shows there are moments when flexible, impact-first loans can be transformative.
When exploring these opportunities, it is important for nonprofits to keep a few rules in mind:
- (Almost) never seek a loan in lieu of a grant. If given the choice between a grant or a loan of the same size, always take the grant. While existing supporters are your most likely lenders, only ask them to consider a loan if it would be in addition to a grant or if it would be in a significantly larger amount. Our nonscientific rule of thumb is to take a loan if it is five times larger than the grant would be. For foundations that are not already supporters, cannibalization is less of a worry. In fact, some foundations may find it easier to start a new relationship with you through a “get to know you” loan rather than a grant.
- Never borrow to cover your operating deficits. Closing a deficit is not easy , but borrowing usually makes things worse.1 The only exception is if your restructuring plan includes the sale of an asset—usually real estate—that you want to borrow against until the sale goes through.2
- Never accept a loan without knowing how you will repay it. Only borrow if you have an identified source of repayment (like the return of the bail/bond paid). This could be money due to you on a government contract, a committed refinancing when a project reaches a milestone, the proceeds from an asset sale, a committed gift or grant, or earned income in which you are highly confident. Be honest with your lender about the risks associated with the timing or amount of the repayment sources. It also pays to have a plan “Plan B” prepared in case things don’t work out.
- Work constructively with your potential lender to find mutually agreeable terms. While failing to deliver on a grant can make you and your funder sad, defaulting on a loan is far worse. It can cause stress for you and your team, create contractual problems with donors and vendors, lead to a qualified audit, discourage donors, and make board members anxious. A secured lender can even seize your assets. The good news is that if your lender is a foundation seeking to make a PRI, their primary motivation is to advance your mission.3 While they rightly want to get their money back (it’s a loan; not a grant!), they should not want to set you up for failure. Work together to find terms that address both of your needs, including realistic contingencies. Things to consider include built-in extensions for project delays, partial guarantees from board members or other “believers,” performance-based repayment schedules, flexible reporting requirements, and other forms of risk sharing.4 If the lender does not want to engage and says “take-it-or-leave-it,” then leave it.
- Articulate how the loan will advance your mission. Demonstrate how you will use the loan and the impact it will have. If the money is being used to make a long-term investment—a building, technology, etc.—calculate the lifetime impact. Also consider whether the funding will encourage, support, or make available other funders. The ability of flexible, risk-tolerant capital to entice others usually goes under the heading of “leverage.” For example, if a $1 million PRI loan allows $9 million in more conventional financing to become available to pursue a $10 million project the PRI gets “9 to 1” leverage. PRI-makers love
- Treat Your PRI Lender Fairly. PRI is precious. It should not be squandered in situations where a conventional lender would have been willing to make you a loan on the same or similar terms. If you are speaking to a PRI lender and conventional lenders in parallel, let the PRI lender know. If you end up borrowing from the conventional lender, you’ll have protected a relationship that you might need in the future.
None of the above is to discourage a nonprofit from engaging foundations for a PRI loan or a foundation from actively seeking out opportunities to extend credit. Indeed, BCBF would not be where it is now but for the support of NYPRI. Capitalizing on these opportunities requires forethought, both with respect to terms and timing. Nonprofits should identify and approach would-be lenders in advance of any imminent need to explore potential opportunities. Foundations interested in making PRIs should be proactive and communicate what they are looking for to would-be nonprofit loan recipients, rather than expect opportunities to come knocking on their doors. Nonprofits and funders should recognize that loans usually involve a more intense, long-term, high-stakes, relationship than grants. It’s not just about agreeing on the financial terms; mission fit and personal trust are vital as well.
There are many win-win opportunities out there to put impact-first capital to work. However, despite the increased interest in PRIs, most of these opportunities will remain undiscovered unless borrowers and lenders actively work to discover and co-create them.
- Worse because interest costs add to the deficit, because the lender may require security, or because the money makes it “okay” to have a second year of deficit which is often the road to perdition.
- A different set of complex financial, philosophical, and legal issues arises then borrowing against endowment assets which are, in effect, margin loans most often provided by the financial institutions that hold the assets. These issues are not relevant to most nonprofits since so few have the benefit of endowments.
- While a foundation may choose not to make a PRI for financial reasons—e.g., too much risk—Internal Revenue Service (IRS) rules prohibit them from making a PRI for financial reasons.
- It’s a mistake to focus too much on the interest rate. IRS rules make foundations very hesitant to ask for market-rates of interest, so you are probably already getting a good deal. Other terms often matter more.
John MacIntosh is Managing Partner of SeaChange Capital Partners, a nonprofit which manages the New York Pooled PRI Fund.
Peter Goldberg is the founding Executive Director of the Brooklyn Community Bail Fund.