Social impact bonds (SIBs), development impact bonds (DIBs), and other “pay-for-performance” social financing innovations are hot topics these days. Indeed, the hype has now far outrun reality, with a great many examples of reports and conferences but precious few actual specimens to dissect. As Antony Bugg-Levine, CEO of the Nonprofit Finance Fund told me, “This market is only going to get exciting once things start to move from talk to action.” He admits, however, that a lot of the early “beautiful theorizing” ran into a hard collision with reality, which is “always harder and more complicated” than the boosters predict.
As recently discussed in SSIR, SIB and DIB advocates hope that private foundations and impact investors will use these bonds as a way to facilitate new forms of cooperation and thereby deliver positive impacts at scale. The promise of an impact bond is to create a new market that is attractive to private investors who want to make modest financial but significant social returns. Foundations also may be investors and can play a role in structuring deals, de-risking investments by co-funding certain hard-to-quantify social outcomes, and offering guarantees. Governments, seeking new ways to innovate, are interested in SIB contracting with nonprofits and have done so in the UK.
But of course, a big problem is risk. SIBs and DIBs transfer performance risk from the funder to the implementer (shared with the investor in some circumstances). The implementing agency or service provider has to focus on delivering results. This transfers a fair amount of risk to the service provider, usually a nonprofit organization, since the failure to deliver the promised results means that the end payer is not obliged to provide the funding. Since most foundation funding to nonprofits is based on paying for inputs (such as funding for protecting the environment or reducing youth incarceration), with the funding delivered prior to program implementation, this demands a major change in nonprofit practice—and it's not clear just how many nonprofits have an appetite for this kind of risk.
My organization, East Meets West (EMW), has been involved with pay-for-performance grants for the past seven years and has created a way to reduce our performance risk. As part of a 2007 deal with a program of the World Bank, we were obligated to borrow up to $1 million to develop village water systems in Vietnam. To collateralize the loan, we asked a group of board members and major donors to put up that amount of money in the form of a donation to a guarantee fund. The guarantee fund thus eliminated the risk to our balance sheet, and the World Bank paid us in quarterly installments based on independently audited results (the number of successful household water connections). Once the program ended, we told the donors that they could re-purpose the funds. Some chose to roll them over into our general fund, others directed them to favorite EMW programs, and one asked for his money back.
EMW has completed three major DIB projects in Vietnam, with three more underway at present in Vietnam, Cambodia, and Laos. According to Bugg-Levine, there are at least 30-50 other SIB or DIB deals completed or underway in different parts of the world. Toby Eccles, founder of Social Finance (the organization that originated the SIB and DIB), told me that there needs to be a “major cultural change” both in funding agencies and the nonprofit sector before the market can really take off. “A lot of groups can’t manage this sort of risk,” he noted, arguing that with any promising new social financing innovation, all parties need intermediary organizations like Social Finance to help figure out the most appropriate models.
In fact, says Eccles, the most important promise of SIBS and DIBS is not the financing itself—it's the change in culture. He imagines a day when government funds civil society organizations based on their ability to deliver social outcomes and offers them maximum flexibility to figure out how to accomplish those results. “DIBS and SIBS are really about being outcome-oriented constructs,” he explained, where all parties are focused on quality service, social outcomes, good performance measurement, and customer satisfaction.
At EMW, this cultural change was a major result of our approximately $30 million in pay-for-performance financing for education, clean water, and sanitation. We have been successful in delivering the agreed-on results at the agreed-on cost, but perhaps more importantly, the outlook of the whole organization has shifted from meeting donor requirements to delivering outstanding service. If the customers are not satisfied, we don’t get paid. At times this feels something like performing a trapeze act without a safety net, but for those organizations brave enough to try, Bugg-Levine and Eccles think significant new sources of funds will be coming on line.