Research Friday: Social Impact Bonds: A New Tool for Scaling Impact
Welcome to Research Friday! As part of a continuing weekly series, each Friday we invite a nonprofit expert to highlight current research reports or studies and discuss how they can inform and improve day-to-day nonprofit practice.
“I cannot help fearing that men may reach a point where they look on every new theory as a danger, every innovation as a toilsome trouble, every social advance as a first step toward revolution, and that they may absolutely refuse to move at all for fear of being carried off their feet.”
—Alexis de Tocqueville
Alexis de Tocqueville, a French early nineteenth century political thinker and scholar known for his book Democracy in America, often pondered questions of societal well-being, or social policy. De Toqueville’s quote speaks to resisting complacency regarding society’s complexity and invites people to think of new and innovative solutions for bringing change. This kind of phenomenon can be seen in a 2011 joint report from Social Finance, Inc. and the Rockefeller Foundation, titled: "A New Tool for Scaling Impact: How Social Impact Bonds Can Mobilize Private Capital to Advance Social Good." The purpose of this blog post is to summarize the information from this report.
Social service and nonprofit programs have traditionally been supported through philanthropy and government contracts. The last five years has seen shrinking funds from both the government and philanthropic sectors due to a recession economy. Needs continue to grow beyond what philanthropy or government can provide. The emergence of microfinance and social entrepreneurship has given rise to new ideas about the role of venture capital in the social sector. There has been some discussion about for-profit alternatives to the traditional nonprofit model, such as “B” (for benefit) and “L3C” (Low-profit Limited Liability Company) corporations, which combine low profits with a social mission. However, there are questions surrounding the inherent stability of these new business models, given the complexity of financial and other federal and state regulatory requirements. One such model is the Social Impact Bond (SIB).
SIBs — Funding Innovation Moves From Philanthropy to the Market
Philanthropy and government are both fiscally limited, in terms of funding growth, to scale social programs that meet the rising demands creating a growth gap. The notion of venture capital in the nonprofit sector is relatively new .The nonprofit sector has not traditionally been an area where investors assume risk by providing capital to high potential organizations and programs. This risk assumption is the SIB innovation.
SIBs provide an alternative to traditional philanthropy, government contracts, and low profit corporations. SIBs are venture capital. SIBs align “the interests of nonprofit service providers, private investors and governments.” Their purpose is to “raise private investment capital to fund prevention and early-intervention programs that reduce the need for expensive crisis responses and safety-net services” (p. 4).
(Report, p. 11).
The Mechanics of SIBs
The report lays out the mechanics of the SIB as follows:
- An intermediary organization issues the SIB. The intermediary will raise capital from private investors for long-term investments.
- The intermediary will fund and oversee evidence-based prevention programs. It coordinates all SIB parties, provides oversight, and directs cash flows.
- Intermediary-funded nonprofit organizations will produce improved outcomes that reduce the need for safety-net services. There is a suggestion that this funding will leverage government contracts in the human or social services arena.
- The intermediary only pays the return on the investment for programs that work, based on the findings of independent evaluators.
- Investors hope to receive back their principle investment amount plus a modest profit.
Ultimately, the role of government will be to pick up and fund or extend funding for what the private venture or investment capital has funded toward scaling-up. The report argues that few government contracts are performance-based and the role of evaluation distinguishes the SIB from government contracts. Nonprofit organizations rarely have the financial ability to scale-up effective programs for change. The SIB, on the other hand, is a flexible financing mechanism that can adapt to community needs and program delivery based on evaluation.
SIBs are unlike municipal bonds or other infrastructure bonds. With SIBs, the investor bears a higher risk of losing all of his/her principle should the outcome not be met. In order for this not to occur, the intermediary organization must manage risk by overseeing the program’s outcomes. Investments typically take a portfolio approach.
SIBs are not a panacea for nonprofits, but rather a move toward additional access to funds that do not require fundraising and the constraints of philanthropic or government funding. Arguably, SIBs will allow organizations to adhere to organizational goals while meeting community needs in the absence of crisis.
Components of Evidence Based Success
The first SIB was launched in the UK by Social Finance, Ltd. The fund raised the equivalent of 8 million dollars from foundations to fund a comprehensive prisoner re-entry program. The fund was backed by the British Ministry of Justice and the lottery system, based upon proven outcomes to repay investors. Outcomes were evaluated based on the number of times the ex-offender was reconvicted. Based on the positive outcomes, investors were reimbursed if one-year post-release reconvictions decreased by 7.5 percent.
The Role of Evaluation
SIBs rely on the role of external evaluators to provide summative evaluations to measure program success. Summative evaluations were chosen, rather than random, control-based experiments, based upon cost (p. 19). Robust data collection is called for when selecting how programs will be evaluated.
The report is weak on addressing issues which might occur as a result of data mining and other biases in evaluations which are not a random, control-based experiment. Further, the report does not provide details in the mechanics section, such as how the less-costly evaluation meets the rigor for testing a model of innovation.
Impacts of SIBs — It is too early to tell.
The risks associated with SIBs include the failure to properly vet the intervention. The report does not provide much information on how the vetting process is administered. Other associated risks involve the potential for poor execution and inadequate evaluation. The intermediary faces great risk in administering the capital—given the need for multi-disciplinary knowledge encompassing private, nonprofit and government budgets. Government and political risk is large as well, carrying with it serious repercussions.
Aside from risk management, SIBs lead to a new school of thought when looking at the financing of community problems. Ultimately, we might see new banking institutions and/or social stock exchange where shares are bought and sold based on the strength of social investments. In the meantime, it is important to think about the role of evidence-based evaluation in programming. It is also important to recognize that scaling-up is not necessarily the answer for solving society’s complex problems. Place and context matter. SIB investors should consider place and context before making high potential societal investments.
In conclusion, we should remember the words of de Tocqueville, which caution us against complacency. Innovations are needed to solve community problems. New financial structures and markets will certainly emerge and will involve a variety of actors from the for-profit, nonprofit, and government sectors. It is not a question of “if,” but of “when” this will occur. The report begs the question of whether SIBs are any different from the recently coined term, “venture philanthropy” which shares principles associated with microfinance as do SIBs. The real question to ask yourself is: “Will you be involved in the creation of new structures for financing community innovation?”
Patsy Kraeger received her doctorate from the ASU School of Public Affairs in May of 2011. She also received a graduate certificate in nonprofit leadership and management from the ASU Lodestar Center for Philanthropy and Nonprofit Innovation.
Social Finance, Inc. Social Impact Bonds: An Overview. “A New Tool for Scaling Impact: How Social Impact Bonds Can Mobilize Private Capital to Advance Social Good." 2012.<http://www. socialfinanceus.org/sites/socialfinanceus.org/files/small.SocialFinanceWPSingleFINAL_0.pdf>.