As Prescribed

In honor of Rare Disease Day on February 28, 2025, we will publish a series of posts throughout the month on As Prescribed and Health Law Scan, focusing on issues impacting the rare disease community. 

Private foundations providing support, resources, and advocacy for individuals and families affected by rare diseases have played an important role for more than 30 years in the advancement of treatments for rare diseases. Much of this support has been in the form of grants to nonprofit institutions to help fund research on promising treatments.

However, private foundations have also funded research and development projects conducted at for-profit life sciences companies by means of program-related investing (PRI). PRI can be done in a number of ways, including through a loan, the purchase of stock, or a license paying royalties. In light of the federal government’s potential cutback of funding for the life sciences, the role of private foundations in supporting for-profit life sciences companies is more important than ever.

PRI by private foundations evolved out of the Tax Reform Act of 1969 (the 1969 Tax Act), which imposes fines on private foundations if they make “jeopardizing investments.” A jeopardizing investment is an investment that could imperil a private foundation’s ability to carry out its charitable activities. Although the concept of a jeopardizing investment would rule out investments made by a private foundation in a for-profit life sciences company, a private foundation can make a PRI in a for-profit life sciences company if three conditions are satisfied:

1. The primary purpose of the investment must be to advance the foundation’s charitable objectives.
2. Neither the production of income nor appreciation of property can be a significant purpose of the investment.
3. The funds invested cannot be used directly or indirectly for political purposes.

Investments made by private foundations in the life sciences have been significant. According to one source, between 2002 to 2017, philanthropic investments in life sciences increased five-fold in the United States to $2.6 billion and outpaced the growth of investments from both industry and the federal government. An example of a successful PRI by a charitable foundation in a for-profit life sciences company is the investment made by the Cystic Fibrosis Foundation in Vertex Pharmaceuticals. It led to the development of the first drug to address the underlying cause of cystic fibrosis and helped the Cystic Fibrosis Foundation significantly increase its funding through the sale of its royalty rights in the cystic fibrosis treatments developed by Vertex Pharmaceuticals.

There are many ways that a private foundation can invest in a for-profit life sciences company, including:

1. Convertible notes (debt instruments that can be converted into stock)
2. Simple agreement for future equity, or SAFE (another instrument that can be converted into stock)
3. Equity—the purchase of stock
4. Royalty—an arrangement to receive a percentage of net sales

A private foundation that wishes to make a PRI will need to comply with the following conditions:

1. The funds from the investment can only be used by the for-profit company for the project being funded by the foundation.
2. The for-profit company must provide the foundation, a least once a year, with full and complete reports on how the funds from the investment were used.
3. The foundation will need to identify in IRS Form 990-PF any PRI made in the filing year.

Other tax advantages of PRI:

1. PRIs count toward a foundation’s required 5% charitable distribution in the year the investment is made; and
2. PRIs are exempt from the excess business holding tax, which usually comes into play if an investment represents more than a 20% interest in the for-profit company.

Some private foundations, going further than just investing in an existing for-profit life sciences company, have created for-profit life sciences companies focused on pursuing the development of treatments for rare diseases the cure for which is the charitable objective of the private foundation. The creation of a for-profit life sciences company by a private foundation should be carefully considered and structured to avoid any conflict of interests and not jeopardize the nonprofit status of the private foundation. There has also been a growing interest on the part of private foundations to increase funding of life sciences companies by becoming limited partners in venture funds created to fund for-profit life sciences companies.

When considering making an investment in a for-profit life sciences company or to become a limited partner in a venture fund, a private foundation should consult with its attorneys to (1) navigate the tax issues raised by such an investment and (2) properly document the transaction.