Social Impact Bonds: trendy distraction or useful tool?

In these times of change and uncertainty, many not for profit organisations are looking for solutions. Social Impact Bonds (SIBs) are a type of social finance which present new opportunities for additional funding.

There are two key aspects to SIBs: they are bonds, that is financial instruments used for raising funds, similar to loans, and the funds raised are used for social impact. Specifically:

• the borrower defines the loan terms
• investment is by one or many, all on the same terms
• the borrower uses the loan for largely social outcomes: for a charity often in programme investments
• the borrower pays a yield (interest) on the loan which may be modest against commercial rates. The lender receives additional compensation by knowing of the social benefits being achieved.

From this outline, it is apparent that SIBs can offer charities an extremely broad range of possible finance solutions. From the SIB funded projects that are already emerging, we can distil three main purposes:

• Bridging: repayments are met from a later receipt, such as a Government payment by results. The bond funds the work in advance of earning the payment.
• Capital funding: for equipping buildings,or working capital on establishing a new social venture.
• Income support: allowing low yields or progressive write-offs to support expenditure, for example during a new venture’s formative stages.

In each case, the funds need to be serviced and, in some cases, repaid in an overall structure that will interest the chosen investor group, be that private individuals or companies, local authorities, charitable foundations or other not for profit organisations.

The structures may be higher yielding to compensate for long tie-ups of capital or higher risks, or low yield for lower capital risks. They may mirror share-type investment risks or loans. They may be structured with built-in tax reliefs for the investor or even listed on recognised stock exchanges to make them more liquid.

This variety of terms and structures is the indicator of one of the key but less talked about benefits of the SIB. Indeed, it is perhaps the most important aspect. They are risk management and risk sharing instruments. They allow us to take risk from one party and pass it to someone better able to carry and manage it.

Consider a small charity providing support for ten ex-offenders finding it difficult to manage the commitments of housing. It is paid when its beneficiaries have been in stable housing for 12 months. It budgets for eight successes. In a bad year, with two extra failures, it loses 25% of its budgeted income. However, if ten such charities are supported by a single fund, additional failures are averaged across the ten, and so are more manageable. If this averaged additional cost is allowed for in setting the bond terms, the funders can carry the shortfall, still earning an acceptable return in this part of their investment portfolio.

Applied well, these are a useful tool. Badly designed or indiscriminately used, they may be a poor use of valuable resource. If you want to discuss this tool further then get into contact with a charity accountant.