Nonprofits Are Uniquely Positioned to Harness the Oncoming Tidal Wave of Catalytic Capital

A tidal wave of catalytic capital is gathering. Let us not squander its force. Since 1969, when program-related investments (PRIs) were first written into the U.S. Tax Code, U.S.-based private foundations could make investments that count as grant distributions whenever there was a case to be made that those investments would not have been made by mainstream investors. The tax language that defined PRI-making in American philanthropy also forms the basis of the broader trend of catalytic capital investing in global philanthropy, an approach that often deploys charitable capital — in the form of grants, recoverable grants and PRIs — as well as noncharitable, impact-seeking capital, into investments that prioritize impact and address important capital needs neglected by mainstream investors.

Catalytic capital programs are built to alter the risk/return profiles of high-impact companies, projects or funds to bring mainstream, economically motivated investors to the table (whether at the same time or in subsequent investment rounds) to support solutions that would otherwise remain overlooked. Writ large, this global trend gives us hope of addressing the world’s most pressing problems at a scale unattainable by nonprofit programming alone.

These days, philanthropists are expanding the toolkit they use to give, including catalytic capital, at an accelerating pace. For example, a decade ago, you could count on two hands the number of PRIs that had ever been directed toward any area of science and engineering innovation globally. In contrast, today, the Catalytic Capital Consortium has started to mainstream the vocabulary of catalytic investing. Foundation Directory Online reports hundreds of millions of U.S. dollars being deployed annually as PRIs from 2019 through 2021. Additionally, billions of U.S.-based philanthropic and deeply mission-motivated dollars teeter on the threshold of deployment into for-profit solutions that aim to advance a social or environmental goal (and would otherwise struggle to raise sufficient financial support).

The tax code does not require that the firms receiving and managing catalytic capital have any particular tax designation. They can be nonprofit, for-profit or other less frequently used forms (e.g., low-profit limited liability companies, public benefit corporations, etc.). This means that recipients’ corporate governance systems are often not purpose-built to steward catalytic capital toward philanthropists’ missions. As history has shown over and over, good intentions can easily erode in the face of the Goliath of private benefit, especially within programs using market-based tools, intended to attract economically motivated actors, and where few would notice compromises on impact-first priorities on a day-to-day basis.

One recent headline-grabbing example of the tension between the public good and private benefit is OpenAI, a grant-funded research endeavor that evolved into a for-profit venture whose actions have far-ranging and oft-debated social consequences. Its nonprofit governing board was purpose-built to protect against unintended social consequences, while its investors, staff, management and many others’ interests drive toward building a thriving for-profit business. This is not to say that OpenAI is good or bad, or that its recent leadership transitions are well-founded or misguided, but rather that it is a salient example of the tension that inherently exists at the nonprofit/for-profit boundary.

While nonprofit public charities are well positioned to safeguard the integrity of catalytic investments, there are too few ready to receive and steward catalytic capital at the scale needed to meet the coming demand from catalytic capital asset owners and allocators. Without sufficient nonprofit public charity intermediation, there is little preventing the Goliath of market forces from pulling catalytic capital interventions down the slippery slope toward private benefit. We need new and existing nonprofits to take on new Davidian roles.

Building nonprofit infrastructure to steward catalytic capital

In 2014, I founded a nonprofit public charity called Prime Coalition that aggregates catalytic capital to deploy toward scalable solutions to climate change — one domain among many that needs this type of intermediation. As we celebrate 10 years of work (and many more to go), it’s clearer than ever that nonprofit public charities have critical new roles to play in this emerging era of market-minded philanthropic giving. Here are five roles I believe nonprofits are uniquely positioned to step into.

1. Be the founder of impact-first investment funds

When a philanthropist wants to deploy catalytic capital, they can do so directly, or they can partner with intermediaries who specialize in pooling and deploying catalytic capital from many sources toward a shared mission. Founders of investment programs set up formation documents and procedures that everyone must follow over the course of the program’s lifecycle.

As founders, nonprofits can play a pivotal role in building a strong, unbiased case for the program as a whole, selecting the right-fit investment managers, architecting the governance, codifying impact-first investment criteria and more. It is strongly in nonprofits’ interests to do these things to advance our nonprofit missions — the reason we exist.

Based on our first 10 years of experience as a nonprofit intermediary, we’ve defined seven phases in the lifecycle of any impact-first investment program: hypothesis, substantiation, design, construction, fundraising, implementation and evaluation. We consider them our internal how-to guide for launching any new catalytic capital program.

Throughout these phases, there are many ways for a nonprofit founder to strengthen the case for the program’s existence, prioritize mission and set the future direction of all fund activities. For example, Prime sets a high bar for impact potential and for how we expect this potential to be assessed. We also require that investment programs we establish must not make investments where mainstream investors could provide ample support without our involvement, even when the impact projections are high. While it is counterintuitive to most investors to step away from a “hot deal,” this “additionality” is the essence of why a market-driven effort does or does not deserve charitable support.

2. Link investment manager compensation to impact

In order to imagine market-driven solutions achieving commercial scale that might also make large-scale impact as intended, we want our impact-first investment managers to choose companies and projects guided by their business acumen. But we need them to choose with their charitable-purpose mindset first and foremost.

To steward catalytic capital requires that investment managers choose solutions that, by definition, have unacceptable risk/return profiles for mainstream investors — and also presents important opportunities for impact-linked compensation. Both the authorship and implementation of impact-linked compensation policies must occur apart from those who stand to benefit from those decisions, leaving the experts at mission — the nonprofit public charities — well positioned for this role, and singularly able to set appropriate impact milestones, unbiased by personal gain.

3. Aggregate catalytic capital

Over the past century, to accommodate philanthropic giving behaviors that expanded alongside American economic progress, the U.S. has built a massive infrastructure of nonprofit public charities. These organizations are positioned to receive and steward tax-deductible grants from philanthropic asset owners to advance a wide variety of charitable purposes.

It is time we had a catalytic capital marketplace that functions at a similarly meaningful scale to address our global social and environmental challenges. To meet that need, nonprofit public charities must grow their capacity to raise, receive, manage and report about complex incoming financial transactions, including traditional and recoverable grants, PRIs and non-tax-exempt, mission-aligned investment capital. The nonprofit should be a destination for philanthropic asset owners to efficiently deploy catalytic capital.

Building this nonprofit infrastructure not only holds market forces accountable, but also allows the market to behave in ways that are uncommon among for-profit investment firms, such as reducing investment minimums in the spirit of inclusion and viewing investor relations beyond mere financial transactions. In today’s nascent catalytic capital market, an educational posture with new-to-catalytic-capital investors is vital for any program to serve as an easy on-ramp to catalytic investing.

4. Provide third-party services during the investment process

As nonconflicted and expert third parties, nonprofits can assess deals against underwriting criteria pre-investment, staff governing and advisory committees that have gating authority over investment decisions, drive post-investment tracking, and report impact metrics. They can also assess investment managers’ performance toward positive impact outcomes and away from unintended social and environmental harm.

Conducting these activities as a third party removes the opportunity for even the most mission-aligned investment managers to tip the scales knowingly or unknowingly toward private benefit.

5. Influence broader systems

If catalytic capital is a gathering single wave, and crowding-in market capital is the rest of the ocean, then nonprofits can change the strength and direction of the wind or the shape of the shoreline. Nonprofits can shape the landscape by, for example, planning grant-supported programming around investments to work on the regulatory environment, policy, community partnership, and other systemic conditions that will tip the scales toward favorable social and environmental outcomes.

Imagine a catalytic equity investment into a novel grid capacity energy storage company that also comes with nonprofit capacity support and expertise to work hand-in-hand with regulatory commissions to unlock permitting for all energy storage providers. Alternatively, envision a catalytic loan guarantee for a carbon removal project that also includes nonprofit support for community partnerships, setting a best-in-class, and, ultimately, money-saving precedent for carbon removal project siting processes elsewhere. This is hard work for the public good beyond one company or project — technical assistance that is not typically provided through platform services from for-profit investment firms.

Supporting nonprofit infrastructure while deploying catalytic capital

It is effortless for market forces to cause a program to default to the self-interest of its stakeholders, and to lose sight of its own virtuous intent. This is because it is effortful to keep a collective mission front and center. And it is more arduous still to advance good intent to its greatest impact possible.

The best path can therefore seem daunting, but it is also the best path — an exciting opportunity for nonprofit public charities to advance their charitable purposes at scale. As families, foundations, donor-advised funds, corporate giving programs and trusts increasingly deploy charitable capital into market-driven solutions, it is imperative that we support nonprofit public charities in their hard work to ensure that complex catalytic capital interventions avoid inadvertent harm and pursue excellence.

In order to achieve what they mean to, I hope philanthropists of all stripes will encourage nonprofit public charities to step into these new roles, especially as those same philanthropists also take courageous steps toward deploying catalytic capital themselves. With ample support for our nonprofit infrastructure, I can imagine a future in which philanthropists are presented with abundant catalytic investment opportunities — expertly stewarded by trusted nonprofit intermediaries — as well as standardized approaches for asking the right impact-first diligence questions, mirroring the array of options we have with for-profit financial service providers and standard due diligence questionnaires today. That’s the future I want for all of us.

Sarah Kearney founded Prime Coalition based on her experience as executive director and trustee of the Chesonis Family Foundation and the findings from her systems engineering research at the Massachusetts Institute of Technology. She now serves as Prime’s executive director, where her leadership has helped the team deploy over $300 million of philanthropic and catalytic capital toward scalable solutions to climate change since Prime’s founding ten years ago.

In addition to its own impact-first investment programs, Prime provides publicly-available resources that support many hundreds of investment managers to consider the forward-looking climate impacts of their investments through Project Frame and the CRANE tool.

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