Most U.S. foundations seek to preserve the money that funds their grants and operations for the long term. They accomplish this by not giving away more money than they earn as returns on the assets held in their endowments.

By law, foundations must give away or spend on their operations a total of at least 5% of what they hold in endowments every year. In practice, foundations spend more than that on their total grants and expenses – around 8% of their assets in 2018, for example.

One way that foundations can stretch their charitable dollars is by making program-related investments – a philanthropic form of lending. Instead of giving money away, those funds are typically repaid several years later. With this model, foundations can recycle some of their charitable funds by dispatching them again.

The investments may count toward that 5% payout minimum  and must, in the IRS’ words, “significantly further the foundation’s exempt activities.”

That means a foundation’s program-related investments, like the money it gives away as grants, must support work that’s in keeping with its charitable goals. Foundations can accomplish this by supporting, for instance, affordable housing, backing cancer research efforts or supporting efforts that are a part of their IRS-authorized mission.

Foundations may also use program-related investments to financially back either nonprofits or for-profit social organizations, also known as social enterprises.

By injecting funds into organizations that would perhaps otherwise be deemed too risky to attract investment, foundations may use some of their assets as a catalyst that can speed up innovation tied to a cause they support through their grants.

The foundations are free to charge any interest rate they see fit, but must be below-market on a risk-adjusted basis. This keeps the program-related investments focused on the charitable mission rather than the opportunity for gaining a high return on their investment.

Program-related investments are most appropriate for organizations that private investors are unlikely to back due to high risks or expectations of limited financial returns, such as small businesses in low-income neighborhoods.

While program-related investments are intended to be repaid and provide heightened accountability for allocating charitable dollars for both the foundation and its recipient, there are no formal penalties if the money is not repaid. This is because the alternative would have been in the form of a grant, where the money was given with no expectation of repayment in the first place.

Foundations and other large philanthropic institutions have long faced pressure to do more with their money to advance the causes they support.

As of late 2022, U.S. foundations held a total of more than US$1.1 trillion in their endowments and had relegated some of those assets to program-related investments.

Although this practice was established following passage of a comprehensive tax reform package in 1969, relatively few of the nation’s nearly 130,000 foundations have embraced it.

But many of the largest ones, such as the Rockefeller, MacArthur and Bill and Melinda Gates foundations, do regularly make program-related investments to advance their missions.

Jessica Jones is an Assistant Professor of Management & Entrepreneurship at the University of Tennessee. This article is republished from The Conversation, a nonprofit media outlet that uses academic and research content. Find more at theconversation.com.