Robust Intermediaries Key to Social Impact Bond Success

This is a guest post by Steve Goldberg. Steve leads Social Finance’s Social Impact Bond development, and is author of Billions of Drops in Millions of Buckets: Why Philanthropy Doesn’t Advance Social Progress.

By Steve Goldberg

Goldberg PhotoSocial Impact Bonds (SIBs) have the potential to help accelerate the social capital markets in many different ways. Rather than viewing them in isolation, it is important that we recognize the way in which they may catalyze the impact investing movement and bring other forms of private capital to the table. But considerable work must be done to create the conditions to attract, retain and grow these kinds of funding.

SIBs are an innovative addition to the impact investor toolkit. SIBs raise funds from private investors, which are then used as working capital by nonprofit organizations providing prevention programs that can reduce the need for costly government remediation and safety net responses, such as emergency shelters and incarceration. If an independent evaluator determines that the nonprofit programs have lowered the demand for government services beyond a predefined metric, the government repays investors their principal plus a rate of return; otherwise, investors lose their capital.

From a financial perspective, SIBs differ greatly from the conventional mechanisms for funding social services. Private investment offers possibilities that are both more muscular and more complex. Although various kinds of impact investing have been around for decades, there is a consensus among analysts that the field is “now emerging from infancy” and “stands poised to become a powerful vehicle…to address significant social and environmental issues” (see Investing for Impact: Case Studies Across Asset Classes).

However, it is by no means a foregone conclusion that impact investing will realize its potential, which has been estimated in the hundreds of billions of dollars. Although the idea of using profit-seeking investment to generate social and environmental good is moving from a periphery of activist investors to the mainstream, a host of challenges must be overcome to bring the new industry to life.

For instance, to attract capital, SIBs must offer both a compelling investment thesis—how the investment will generate financial returns and increase social impact—and a rigorous business case that convinces prudent investors that it’s safe to take the plunge. While a sizable and motivated group of prospective impact investors finds the SIB investment thesis—that cost-effective nonprofit preventive programs can reduce governmental expenditures, yielding savings to fund returns to investors—plausible and attractive, the investors for the first round of SIB pilots will likely be foundations and charitable trusts of high-net-worth individuals, who are willing to test the concept.

Developing detailed business cases for specific SIBs will be challenging, given the inherent uncertainties involved in producing and measuring social outcomes. Social Finance has been conducting extensive research on various evidence-based interventions, growth-ready nonprofits with strong track records of successful delivery, and the costs and outcomes of existing and proposed services, all of which must be presented in credible financial models. We know that investors will conduct demanding due diligence, as well.

The intensive focus on outcomes imposes stringent requirements for defining metrics, establishing target outcomes, collecting data, and evaluating results. The government’s obligation to repay investors, the amounts due and their timing will be contingent on the results of an independent evaluation, so clear definitions of desired outcomes and unambiguous numerical measures and targets must be set up front. A robust data collection system must be developed and faithfully maintained. The entire system must provide real-time data that can guide and track ongoing operations and provide oversight capability to inform mid-course adjustments, as necessary.

The key to overcoming all of these barriers and weaving together the many players that are needed to make SIBs work are robust intermediaries. SIB intermediaries will need to serve as specialists with expertise in finding effective intervention models, conducting due diligence on nonprofits, organizing public-private-nonprofit partnerships, structuring transactions, raising capital, and managing the whole complex project. Intermediaries must also convince investors that the outcomes can be produced and measured; government agencies that prevention programs can deliver savings; and nonprofits that SIBs can attract long-term growth capital necessary for scaling.

SIBs represent a significant step forward in building the impact investing industry. Its potential has yet to be demonstrated in the United States, but with careful attention to the challenges outlined above, it is poised to catalyze private capital toward advancing social good.