The Three S's of Investment Servicing

This month, we break down the essential elements to consider when designing a PRI servicing program.

Formerly the province of large, national private foundations, Program Related Investments (PRIs) are prominent in community and place-based private foundation portfolios of all sizes across the country. In fact, a small sample of community foundations – just 30 of the roughly 800 in the U.S. – hold nearly $227 million in actively deployed PRIs, both loans and guarantees. While it’s exciting to see more philanthropic actors acknowledging place-based impact investing as a significant asset class, this trend also shows a growing need for active investment management to mitigate the risks of lost capital and unfulfilled impact. Portfolio leakage caused by servicing inefficiency is money not being re-deployed for impact; avoiding such errors starts with careful deal structuring and intentional design of servicing systems.

As both a seasoned provider of back-office servicing support and a partner helping foundations design impact investing programs, LOCUS has first-hand experience with multiple PRI management practices. From that, we find that servicing a PRI portfolio can be broken into four primary, interconnected activities – onboarding, transacting, monitoring and reporting. Foundations can engage with these activities to varying degrees depending on budget, staff capacity, institutional commitment, and impact goals. There is no one-size-fits-all approach, but building a stable portfolio involves a combination of these four activities.

Diving even deeper, impact portfolio servicing processes and procedures used should address three key elements:

Stakeholders.

For many foundations, place-based impact investing is a nomadic practice – responsibilities bounce between program and finance staff for review and proposal packaging before moving through a series of decision-making gates that involve executive leadership, investment committees and boards. Once an investment is made, each of these stakeholders is involved – to a degree – in the oversight of the investment throughout the term of deployment. To satisfy these multiple audiences, it is important to begin with the end in mind: what reporting is needed to inform decisions; how should transactions be recorded on accounting ledgers; what data is required at onboarding versus throughout the life of the investment. This is particularly important for those foundations just beginning their impact investing practice. Having frank, front-loaded conversations about what information must be tracked and reported can save considerable time and re-work as investments are deployed. Further, being honest about necessary information allows staff to build the right-sized approach while providing foundational building blocks for more robust, sophisticated reporting packages down the road.

Questions to consider: Are our borrowers/investees situated to provide the necessary information and data that will roll up into a reporting package? Do we have a grantmaking impact framework that can be abstracted to organize the impact data that is collected from borrowers/investees? How are we equipping finance/administrative staff to be successful at collecting necessary information within the timeframes of our existing board/governance calendar?

Standardization.

One of the unique characteristics about impact investing is that investors, often philanthropies, are motivated at least in part by impact. Often, this leads investors to consider the borrowers/investee’s interest, as well as their own, when structuring investment terms. This practice, of meeting borrowers/investees where they are, can contribute to better impact outcomes, mitigate risk of lost capital and encourage follow-along investment. But common consequence is a lack of standard terms around which to build simple, effective servicing tools and systems. If a foundation is motivated to fill a range of local investment gaps, an objective embraced by some emerging practitioners, then more sophisticated processes and tools must be built and maintained by foundation staff to accommodate and appropriately monitor the unique characteristics of each investment.

Questions to consider: How creative do we want to be with our place-based impact investing dollars? Does the foundation value the ability to be nimble and responsive to myriad community investment opportunities? Are we building an “investment product” and/or launching a simple and standardized loan fund? Do we have or anticipate having borrowers/investees with low capacity or few full-time staff? Are we treating each prospective investment in a highly custom manner, e.g. layering in contingent terms, unique impact covenants and/or acceptable payment methods?

Systems.

Deploying investment dollars for impact often requires foundations to retool existing processes or create them from scratch. Generally, philanthropies use one of three methods for managing PRI portfolios – worksheet-based systems in Excel, modified modules of grantmaking systems or third-party back office support. Each management system has relative strengths and weaknesses. For example, Excel-based worksheets are inexpensive and allow for the foundation to maintain complete control of the relationship with the borrowers, but at the same time, these processes are incredibly manual and reliant on staff oversight. Some foundations have upgraded manual worksheet-based systems by building custom information workflows within grantmaking platforms. This can be one way of providing a more automated backbone for borrower communication, billing and document collection that eases the burden on finance staff. On the downside, this route often requires significant upfront resources – as many foundations bring in a consulting team to build the impact investing modules. This approach also requires ongoing system upkeep to accommodate more nuanced, sophisticated investment terms. Hiring back-office support avoids building internal capacity to service investments and/or maintain an updated, capable platform, but comes at a cost in terms of financial resources.

Questions to consider: What type of risk are we managing for? How many investments are we considering making within the next calendar year? How many full-time finance professionals do we have on staff? How many individuals are involved in executing a transaction? Do the foundation’s impact investing policies/guardrails accommodate the use of different asset types,  e.g. debt, equity, guarantees and recoverable grants? How important is it to my organization that nonprofits who may receive both grant and impact investments access a single portal? How long does it take my organization to upgrade vendors, technologies and platforms?

For more information on this topic, Mission Investor Exchange members can access a recording of LOCUS’ Virtual Brown Bag, Problematic or Proficient: Is Your PRI Portfolio Well-Managed? Those who are not MIE members can reach out to Sydney for a copy of the presentation materials.