/ Juvat / by Niklas Ruf

Social Impact Bond: The greatest misunderstandings

After completing the first German Social Impact Bond, we want to share some of our fundamental insights, particularly since this innovative project approach has yet to be tested on a broader scale in German-speaking countries.

While implementing the project, we were often confronted with a number of opinions on what a Social Impact Bond really is and how it must be structured in order to be considered a true Social Impact Bond in the first place. For this reason, we believe that this summary is both necessary and useful, and hope it will provide greater clarity and orientation going forward.

Misunderstanding #1: A Social Impact Bond = Impact Investing
In public discussion in German-speaking countries, Social Impact Bonds (SIBs) are often presented as an instrument for impact investing. In our opinion, this view is wrong.

With impact investing, the goal is to generate a return on capital as well as a positive social impact. Earning money while doing good sounds appealing. And there happen to be appropriate investment products for this — just not SIBs.

SIBs and impact investing are not only incompatible, but also mutually exclusive. In a previous blog post we described what happens when investors with monetary return expectations usurp SIBs. SIBs are not even an appropriate financial instrument for foundations to invest their capital, since the high risk of a total loss contradicts any non-profit foundation’s obligation to put its capital in low-risk investments. This contradiction cannot be resolved.

Instead, a social impact bond provides a great opportunity to make a “better donation.” It is better not only because there is transparency on how the money is used, but also because there is a real chance of getting back the “invested” money and thus being able to use it for other charitable projects.

Misunderstanding #2: A Social Impact Bond = Earning money at the expense of the less fortunate
We also regularly hear the opinion that Social Impact Bonds allow private investors to earn money at the expense of the less fortunate. This, however, is not correct. In the SIB projects that we implement, one of the main characteristics is that the work with the target group is completely guaranteed for the entire duration of the SIB. The respective target group thus ALWAYS receives support, even if the agreed objectives are not ultimately achieved and the financiers do not get back their money.

In fact, in a SIB the central emphasis on defining specific objectives has a decisive advantage for the so-called less fortunate: Thanks to the clear focus of the project’s activities, it is possible to provide customized support for the target group. In a SIB, project participants can thus receive much more individual and effective support than is often the case in standard programs. And since the program costs are agreed upon with the social service providers in advance, there is no risk that payment of the promised funding will be delayed or completely cut. This means that within a SIB money is never earned at the expense of the less fortunate. Instead, financial funding is provided for targeted and effective work.

Misunderstanding #3: A Social Impact Bond = Saving on public funding
While it’s true that the governmental institutions can save money by commissioning a Social Impact Bond, they don’t have to. Instead, with a SIB the governmental institutions have to decide how much they would like to pay (and can afford to pay) if a clearly described social problem is successfully addressed. This is why SIB projects are referred to as pay for success projects — and not pay for cost savings projects.

Since in most cases the governmental institutions cannot know what specifically will be achieved with the funding they provide (because the specific achievement of objectives is generally neither defined nor documented), a SIB is certainly a welcome new financial instrument. What is decisive for us is that in a SIB, public funds are used in an objective-oriented way and the degree of target achievement is precisely monitored. This makes clear what does and doesn’t work and can serve as a basis for future funding decisions. If savings potential can be realized on top of that, then this provides additional value. But still this is optional added value.

Misunderstanding #4: A Social Impact Bond = Success-dependent payment of social service providers
Unlike what is often claimed, in a Social Impact Bond the social service providers are guaranteed complete payment for the entire duration of the SIB. In a SIB, only the upfront financiers are paid based on the fulfilment of the objectives, not the social service providers. As a result, the entire risk lies with the upfront financiers, thus allowing the project partners in the field to focus on their actual work.

The SIB structure also offers another major advantage for social service providers. By significantly simplifying the financing process and eliminating the strictly prescribed use of funds, the existing budget can be flexibly used. This gives social service providers significantly more time and resources to work with the target group — which is exactly what a SIB should offer.

Misunderstanding #5: A successful Social Impact Bond = Achieving the defined objectives
Does a Social Impact Bond fail if the agreed objectives are not achieved? In our opinion: no. After all, a SIB cannot fail once it has been established. Why are we so convinced of this? It’s quite simple. As soon as a SIB is launched, all of the participants have already won:

  1. The governmental institutions get a project for a social problem that they have identified and that is geared towards its defined objectives. And the governmental bodies only have to pay if the agreed objectives are actually achieved.
  2. The non-profit upfront financiers provide funding for an objective-oriented and comprehensively evaluated project. At the same time, they have a real chance of having their funds repaid plus a small amount of interest so that they can use these funds for other social projects. What would normally be a one-time donation (“the lost contribution”) turns into a potentially reusable use of capital by contributing to a SIB (“the better donation”).
  3. The social service providers receive guaranteed funding through a much simpler process, thus giving them greater flexibility to implement the project. As a result, they have much less administrative overhead and more time to work with the target group.
  4. The target group receives offerings tailored to their specific problems that are guaranteed for the entire duration of the SIB, regardless of whether the objectives are achieved.
  5. The general public gets transparency on how their tax money is being used. And it gets clarity on how much money is being spent and which outcomes are being achieved on specific issues in the social sector.

For these reasons, we are convinced that a Social Impact Bond cannot fail.