Impact investing as a foundation strategy
(a) What does impact investing mean when applied to foundations?
Impact investing generally refers to investments that are made with the goal of generating a positive impact in areas where people currently face numerous challenges. This can involve investments relating to health care and environmental protection, or investments in programmes designed to alleviate or eradicate poverty. However, this doesn’t mean that such investments should not produce a financial return.
In the case of foundations, impact investing is used to invest a foundation’s assets as efficiently and sustainably as possible in order to achieve the biggest possible long-term benefits with regard to the particular purpose the foundation was set up for.
(b) What advantages does impact investing offer as a foundation strategy?
It is often seen that traditional foundation investment activities which focus on distributing the funds of the foundation by way of non-returnable contributions (“à fonds perdu”) do not achieve the desired benefits in line with the purpose of the foundation. Impact investing offers a solution here. Unlike a traditional foundation strategy that focuses on such “à fonds perdu”-contributions, impact investing involves a different approach in which early-stage support is provided to start-ups operating in areas related to a foundation’s purpose. Instead of simply providing non-returnable contributions, a foundation will provide equity – i.e. it obtains shares in the company in question.
In other words, impact investing can be used to ensure that a foundation whose funds help increase a company’s value will also be able to participate in that company’s commercial success, and then use the return on the investment for further investments – for example by reinvesting in a different start-up. Such an approach also ensures that a foundation will not be at a disadvantage vis-à-vis other external financial investors (who would indirectly benefit if the foundation used the “à fonds perdu” approach, which would go against the arm’s length principle).
(c) Can a foundation that uses impact investing maintain its tax-exempt status?
In principle, yes.
In practice, however, experience has shown that many tax authorities take a critical view of impact investing with regard to tax exemption. The main criticism here is that impact investing supports a business activity, and business activities cannot be granted tax exemptions.
It is therefore extremely important that any foundation planning to engage in impact investing informs the responsible tax authority of its intention in advance. Discussions can then be conducted to determine whether the foundation will be able to obtain/maintain tax-exempt status.
Profits achieved with impact investments by foundations ensure that foundations are treated the same as other external financial investors, as the latter always earn money when their investments develop positively. In other words, it must be ensured that foundations are not placed at a disadvantage vis-à-vis other external financial investors. In case of a return on investment, the foundation’s assets increase which, as a “side effect”, ultimately furthers the charitable goals of the foundation.
(d) What else do foundations need to pay attention to when pursuing an impact investing strategy?
Impact investing involves a long-term strategy that needs to be continuously pursued over a period of many years. The approach involves supporting start-ups in a very early stage of their development, which means that the start-up’s research and development work can often go on for years after the investment. In other words, there will be no immediate financial returns, and in some cases little or no returns at all.
This means that any foundation planning to implement an impact investing strategy should make certain organisational and legal arrangements, and possibly certain modifications as well, in order to ensure the necessary continuity of its operations and activities.
(e) How we can help your foundation
We have extensive experience with the implementation of impact investing strategies at foundations, and we will be happy to assist you with the planning and implementation of such a strategy.