Recoverable Grants: The Gifts That Keep on Giving

Many nonprofit organizations consistently raise just enough revenue through government or philanthropic support to cover ongoing program expenses. And those with financing, such as traditional lines of credit, can’t afford or may be prohibited from assuming additional debt. This combination makes it challenging to source the kind of “catalytic” capital needed to fuel innovative research and development, support revenue-generating programs, or bridge transient funding gaps.

Meanwhile, there is a rising generation of philanthropists—entrepreneurs, next-gen inheritors, and other wealth creators—eager to further leverage their resources for positive change beyond traditional grantmaking. One potential solution? Recoverable grants, a win-win for both donors and nonprofits under the right circumstances.

Ins and Outs of Recoverable Grants

As the name implies, recoverable grants are grants to qualifying charitable organizations, typically from a donor-advised fund (DAF) or foundation, that allow for the recovery of granted capital—provided the organization achieves certain pre-set objectives. Such trigger events or objectives are typically spelled out in a nonbinding agreement, along with the timing of the recovery and the interest rate (which can be as low as 0%).

Some donor-advised fund sponsors make these template agreements available. But in general, donors should note that if the organization doesn’t meet its objectives, they are under no obligation to return the funds. In that case, the grant simply becomes a traditional or “unilateral” grant. On the flip side, if the milestones are achieved, the donor gains the satisfaction of having invested in a successful initiative and can recycle those recovered funds back into the pool for future grantmaking.

Beware the L-Word

Recoverable Grants are treated as grants and not loans. That’s a critical distinction on a number of levels, including:

• They’re highly unlikely to violate any of the organization’s existing loan covenants (lines of credit, facilities financing, etc.) because they’re legally subordinate to any traditional debt.
• They are not considered “Program Related Investments” (PRIs), which often come in the form of a loan and count toward the foundation’s 5% annual charitable distribution requirement if they follow certain IRS regulations. Unlike PRIs, recoverable grants come with no additional requirements or risks. They are listed as expenses on the foundation’s or DAF’s statement of activities, just like unilateral grants.
• If a recoverable grant is structured too much like a loan, it could be viewed as debt and have negative implications for the nonprofit’s financial statements. For instance, using binding language or requirement of repayment could result in adverse accounting, legal, and financial consequences for all parties involved.
• Lower cost of capital and friendlier term makes recoverable grants an attractive funding alternative to many traditional loans. This is particularly true when used as “risk capital” for a pilot program with potential for revenue generation or higher success rates in fulfilling mission objectives, even if there is no guarantee.

Recoverable Grants in Action

Meet Chandler, an entrepreneur who contributed $5 million to his DAF upon the sale of his business. He has strong ties to ABC Housing Partnership, a nonprofit developing quality affordable housing for low-income households. ABC plans to scale their successful model to a neighboring community by purchasing a building and developing infrastructure. The organization is confident in their ability to maintain a balanced budget for the new initiative once the upfront development costs are covered. Yet after securing bank financing and private philanthropic support, they still face a $2 million gap before executing their plan.

While Chandler is willing to provide the $2 million, it would deplete 40% of his DAF. What’s more, as an entrepreneur and impact investor, he is interested in leveraging his capital beyond traditional grantmaking. Given the clear-use case, ABC’s proven infrastructure (including grant tracking and reporting)—and a situation that lends itself to a discrete timeline and milestones—Chandler’s advisor suggests structuring the grant as “recoverable.” This would provide ABC with the immediate upfront funding at little or no additional cost, while potentially replenishing part or all of Chandler’s future grantmaking capacity.

Is There a “Cost” to a Recoverable Grant?

To help Chandler with his decision, we quantified the potential financial outcomes of using—or not using—a recoverable grant. Our analysis showed that if ABC successfully met its metrics and $2 million was returned and reinvested in the DAF in year 5, the DAF portfolio value would grow to $6.1 million assuming a 6% compound annual investment return (Display).

Put another way, a $2 million recoverable grant would equate to a $520,000 traditional grant. That’s because a traditional grant (with no opportunity for recovery of funds) would only need to be funded at $520,000 to achieve the same $6.1 million portfolio value in year 5. And while the DAF portfolio ultimately lands in the same spot either way ($6.1 million), the higher impact of the recoverable grant would be transformative for the nonprofit since they could immediately use the $2 million to advance their housing initiative.

By comparison, if only 50% (or $1 million) of the grant was recovered, the DAF portfolio would appreciate to $5.1 million. And if ABC was unable to return any of the grant capital, the DAF’s value would reach just $4.1 million. What if Chandler had shied away from the recoverable grant altogether? Then the $2 million that remained in the DAF would have grown to $6.8 million over the five-year period. Effectively, that means a fully repaid $2 million recoverable grant has a financial opportunity cost of $700,000.

Even if the nonprofit couldn’t meet its agreed-upon goals by year 5—and Chandler failed to recover any of his $2 million—his grant would still play a large role in helping the nonprofit scale their impact without disrupting their secured financing arrangements. He wouldn’t rely on repayment, but if it did occur, he’d maximize his own impact by recycling the funds for another passion cause.

Keep in mind, a recoverable grant isn’t right for every donor—or every organization. But under the right circumstances, it can be transformational. Your Bernstein Advisor can help you determine whether they make sense for you.