Recoverable Grants as a Tool for Impact
Updated: Apr 14
In an era when philanthropy is changing rapidly, and the needs of philanthropists are changing equally as fast, one option many foundations should consider is a recoverable grant. It acts in many ways as a loan but is treated as a grant for tax purposes. For private foundations, in particular, this is helpful, since it means the grant will count towards the foundation’s 5% minimum payout for the year. It also allows foundations to make much riskier “investments” than they could otherwise.
What Is a Recoverable Grant?
A recoverable grant (not a technical legal term, by the way) is a grant, not a loan. It looks like a grant, walks like a grant, talks like a grant, and is handled the same way as a grant, except the grant agreement specifies that some or all of the grant will be repaid or recovered upon the happening of a certain event. So, for example, a foundation could use a recoverable grant to finance some research that has commercial possibilities and get its money back (or a piece of equity) if the research leads to a successful company or product. Another foundation might like to provide bridge financing in the form of a grant to be repaid when the permanent source of income is received (i.e., a government grant or contract).
Recoverable Grant Formalities
Legally and for tax purposes, a recoverable grant is an outright gift to the recipient, albeit subject to recapture if the trigger occurs. So, for example, a foundation can provide bridge financing to the grantee in the form of a recoverable grant, and be repaid when and if the trigger occurs. The lender takes the risk of failure and gets a financial or social return for success. But unlike most loans, there are many fewer formalities. When capital needs to be deployed quickly, that makes a real difference.
The formalities of a recoverable grant are fairly minimal. There is the grant agreement, which includes the repayment provisions and the trigger. Most recoverable grants today contain repayment provisions that are straightforward and not very complex, but they could easily be adapted to a wide range of activities, including potentially sophisticated transactions. It should be noted however that if the document or the transaction looks too much like a loan, the IRS may decide that it is a loan, not a grant. In that case, the lending foundation has to meet the program-related investment test or else (a) the loan does not count towards the foundation’s 5% minimum payout requirement, and (b) if the investment is risky or speculative (which it probably is), the foundation runs the risk of having made a jeopardy investment, which means penalties against the foundation and possibly the foundation managers personally.
Recoverable Grants During COVID
During the COVID crisis, we have worked with several clients who used recoverable grants to finance disaster and response-related activities conducted by nonprofits. In one case, a group of local health organizations (the grantees) got together to purchase personal protective equipment (PPE) for their workers; the foundation deployed cash to buy the supplies in volume within hours. The foundation’s agent held the equipment until the local groups could raise the money to pay for them, at which point they repaid the foundation. In that case, the foundation recovered most of its money, the charities got what they needed at a below-market price, and the local intermediary built a stronger network.
In another COVID case, we used a recoverable grant to finance emergency, forgivable loans to local businesses, with a local 501(c)(3) acting as the intermediary to make and service the loans. Finally, we used a recoverable grant to finance a for-profit-nonprofit joint venture where the risk and profit were being shared, and the recoverable grant was used to finance the nonprofit’s portion of startup costs. The nonprofit’s profits above a certain amount will be used to repay the loan. If there are no profits, the foundation gets nothing, just like a regular grant.
In all these cases, the donors knew the recipients and wanted to provide funds quickly. In each, there was a scenario under which the donor would be repaid. Additionally, there was a mutually desired outcome, and a genuine commitment by the parties to accomplish that result together, come what may.
For-Profit Company Recoverable Grants
Recoverable grants can also be used to finance for-profit companies, but in those cases, the foundation has to exercise “expenditure responsibility” (special rules that apply when a foundation makes a grant to a non-501(c)(3) entity). Expenditure responsibility adds cost and delay, but can also be more efficient than making the grant to an intermediary, and the direct relationship between the foundation and the grantee allows it to exercise greater control over use of funds, quality control, or anything else that is important to the foundation. Each situation has to be evaluated. One size does not fit all.