Alternative investments are becoming more and more common as investment instruments for nonprofit organizations. Alternatives are not your typical investments in items such as stocks, bonds and cash. They are not traded on an active market, even though they are often listed alongside traditional investments on the financial statement. Examples of alternative investments include real estate investments, mortgage notes that are not debt securities, venture capital funds, partnership interest, oil and gas interest, and some equity securities that do not have a readily determinable market value.
Since alternative investments are becoming more widespread, it is important to understand some of the basic facts about alternative investments:
- Valuation – These investments are not actively traded on the market; therefore, valuation is more difficult. Alternative valuation is often based on the net asset value of the investment. It is also important to note that the investment statement does not typically recognize the value of the alternative as of the statement date. There is often a lag between the investment statement date and the date the alternative was valued. For example, an investment statement dated December 31, 2015, may be showing the value of the alternative investment as of September 30, 2015.
- Cost or Market – In the year the alternative investments are purchased, GAAP allows them to be valued at either cost or market. Valuing the investments at cost would eliminate some of the issues noted above. The organization should make a conscious decision in the year the investments are purchased on how they prefer to value them on their books.
- Liquidity and Lock-up Periods – Many of the alternatives have a lock-up period where the organization is unable to withdrawn funds from the investment for a certain period of time. Also, there is often a pre-notification term of days or months before funds can be distributed. Finally, there can be a holdback on final payment until the fund’s audit is complete.
- Partnerships and Limited Partnerships – If the alternative investment indicates it is taxed as a partnership for tax law, the organization may need to receive a K-1. The organization may be subject to unrelated business income tax as a result of the investment that needs to be reported on a Non-Profit’s 990T and the applicable taxes paid annually.
- Reporting – If the organization owns more than 20 percent of the alternative investment’s total value, then the organization may have to consider reporting the investment under the equity method in accordance with generally accepted accounting principles.
- Audit Scope – If the organization obtains an annual financial statement audit, there will likely be extended procedures and additional requests of information to the investment manager in order to audit these investments. This will also result in additional audit time and possibly additional audit fees.
Overall, an organization should have a good understanding of the details of each of its investments and work with financial professionals when considering investment vehicles, especially alternatives.