A great deal of impact investing takes place through traditional financing models including private equity, venture capital, and debt financing. However, there is also a movement to develop new impact investment vehicles that capitalize on both for-profit and government funding for solving social problems. Social Finance UK has pioneered one of these new vehicles: the social impact bond.
Contrary to what its name implies, these are not actual bonds. As Emily Bolton explained during a panel at SoCap 2010, Social Finance UK was originally looking for a way to raise money for programs that addressed social issues. While a good amount of money is flowing microfinance initiatives, it has been harder to drive capital into other issues like education, health, and crime prevention. Social Finance UK developed the social impact bond as a way to address these social issues that government would normally pay for. Here’s how it works: institutional investors invest in a limited partnership. The money is used to finance nonprofits that are delivering programs. Social Finance UK uses a well-developed set of metrics to measure the success of the program and demonstrate the economic value that it creates. If the program is successful, then the UK government agrees to invest in it. The institutional investors receive a return (currently capped at 13%) from the money that the government invests.
As Justina Lei of the Rockefeller Foundation explained, the model is an innovative way of driving government funding for social issues that is far more outcomes-driven than traditional grants. Nonprofits are given the opportunity to demonstrate the potential of their programs with the money provided by investors, however in order to grow and scale they must demonstrate concrete and financially measurable results. The model seems particularly attractive to governments that are frequently scrutinized for the inefficiency of their funding.
As Bolton explains, there are still challenges inherent in the model. Social Finance UK’s pilot ran with a prisoner re-entry program that reduces recidivism rates. In this case, the cost of failure (increased crime and imprisonment rates) is high. In addition, the time frame for measuring results is short – ex-offenders frequently commit another crime within 6 or 12 months of being released. There was also an existing baseline in the form of historical, country-wide recidivism rates against which it could measure the success of its programs. As a result, Social Finance UK was able to easily demonstrate the immediate monetary savings for police departments, prisons, and justice systems. Programs with longer term impact and low cost of failure might be more difficult to fund if investors are seeking short-term liquidity (the pilot program is a 6 year bond) and if organizations can’t demonstrate the economic value being created. In addition, the model only works where you have good metrics that are tied to something that is objectively valuable, which can be a challenge for some social programming. However, the social impact bonds are innovative and others are exploring whether they can be applied more broadly. In fact, Rockefeller Foundation, which funded the UK pilot, is now exploring ways to implement social impact bonds in New York City in collaboration with the city government.
Vale is a second year MBA student at Duke University’s Fuqua School of Business and is interested in how for-profit businesses are finding innovative ways to create social and environmental value and how capital is being driven towards those businesses. Prior to enrolling at Fuqua she was the Deputy Director at Empowerment Group, a non-profit microenterprise development organization based in Philadelphia. This summer she interned with B Lab, auditing certified B corporations and working on the organization’s policy and capital markets initiatives. Vale has a BA in Economics and Political Science from Swarthmore College.