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Should Energy Startups Be Funded as Charities?

Investments in energy start-ups can count as charitable grants. Could this funding approach help get new technologies to market?
December 17, 2013

Just a few years ago, the conference rooms of the Marriott Hotel in Kendall Square, just across the street from MIT, were abuzz with venture capitalists who were going to solve climate change by funding startups with novel solar cell and biofuel technologies. I remember John Doerr, of Kleiner Perkins, tearing up as he talked about the importance of investing in technology to stop global warming.

Those same conference rooms were far more staid this year, at the annual MIT Venture Capital conference. Indeed, energy startups were talked about as charity cases. Literally.

In the last couple of years, funding for new energy companies has dried up or has shifted to companies with more modest goals, such as crunching data to cut energy bills. VCs got burned after several solar companies and advanced battery companies went bankrupt or were acquired for pennies on the dollar (see “For Energy Startups, a Glass Half Full or Empty?” and “A123 Systems Files for Bankruptcy”).

At the conference I learned that the Will and Jada Smith Foundation, along with four other foundations, are funding an effort to develop a new way for energy startups to get funded—by treating them as charities that no ordinary investor would touch.

As it turns out, there’s a provision in the tax code that says that investments in startups can be counted as charitable grants—even if those investments could in the long term bring in huge returns. The catch? The startups have to be ones that are too risky for ordinary investors.

That’s an increasingly easy requirement to meet for many energy companies these days. VCs are wary of energy startups that require large investments, and will take over a decade to provide returns.

Private foundations, however, don’t mind waiting around for returns. Indeed, they’re used to giving away a lot of their money.

In the United States, tax-exempt private foundations make grants totaling $50 billion a year—that could go a long way to helping energy startups. The donations are part of a requirement that such foundations donate at least five percent of their money to charitable causes. The Smiths’ foundation is providing seed money for a new organization—called PRIME—that is helping private foundations take advantage of a part of the tax code that will allow them make investments in startups, but count them as grants that help them meet that five percent requirement.  

According to Sarah Kearney, the executive director of PRIME, private foundations can make investments, and even make big returns on those investments, and still count them as charitable grants as long as they meet two requirements. The first is that the startup serves a philanthropic role. “Advancing science” counts an philanthropy. Addressing climate change and helping poor countries with their energy needs could also count. The second requirement is that ordinary investors wouldn’t touch the startup.

Private foundations don’t often take advantage of this opportunity. One reason is that the team of people in charge of grant making don’t know how to make investments. Another is that there is some risk that the IRS won’t accept the rationale that the investment fits the requirements for being counted as a grant, and getting a confirmation from the IRS can take a year, Kearney says, a long time for a struggling startup to wait for funding.

PRIME is designed to act as an intermediary that takes on that risk, and that has the necessary expertise to make investments. It is registering as a charitable organization with the IRS, so foundations can make ordinary grants to it that they know will count toward that five percent requirement. PRIME will then invest that money in startups that its experts determine count as charities. The organization is at a very early stage, having raised just $180,000 in seed money to get going. It’s in the process of raising funds for its first investments. Much of the early work is being done as “in-kind donations” by energy VCs who want to see more money going to risky energy companies. 

Matthew Nordan, a vice president at the venture firm Venrock, one of the most upbeat energy-related venture capitalists you can find these days (see “A Solar Survivor Has High Hopes”), is one of those VCs. He makes the point that energy is still a huge market, and fortunes are waiting to be made. But he sees the need for new funding models for risky companies. He singled out PRIME as having one of the most promising. 

PRIME’s approach is certainly an interesting model, and one that sounds like it could get more funding flowing to energy companies. But ironically, by revealing these companies as being in need of charity, it also highlights just how difficult it is to bring new energy technologies to market, and how hard it is these days to get ordinary investors interested.

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