The typical structure of social impact investing
Social impact bonds (“SIB”) (which, confusingly, do not necessarily include an issuance of ‘bonds’ at all) seek to channel money to projects with a positive social impact while allowing governments to only make payment once the desired results have been achieved. The appetite for such projects has been growing since the first SIB launched in 2011 and development impact bonds (“DIB”), the close cousins of SIBs funded by non-governmental entities, have seen a concomitant rise in popularity.
While there are several ways an impact bond can be structured, a typical structure involves:
- a risk investor providing upfront capital in order to achieve pre-agreed target outcomes;
- an intermediary, acting as project manager by coordinating and managing the ongoing implementation of the project;
- implementers who execute the intervention and coordinate with the intermediary on the implementation of the project;
- an independent evaluator who evaluates and confirms whether and to what extent the success metrics, as agreed between all key stakeholders at the outset, have been met; and
- an outcome funder who will make payment to the risk investor commensurate with the extent to which the target outcomes have been achieved. Depending on the extent to which the target outcomes have been achieved, the risk investor may receive more or less than its initial investment.
Funding in this structure has typically been provided by way of grant funding, cognisant of the fact that the risk investor is usually a charitable or philanthropic organisation. However, private investors are increasingly applying capital market principles to outcome-based social impact structures, providing the tools to scale up social impact investing to the levels required to meet the targets and deadlines set by the SDGs.
Market trends
Capital aggregation: most basic impact bonds involve just one outcome funder. However, as structures in the sector evolve, we are now seeing DIBs with multiple outcome funders (who themselves may be funded by back-to-back financing arrangements). Under these arrangements, only the outcome funder is party to the transactional documents and back-to-back funding partner(s) can buy into the DIB through the outcome funder. Such collaboration presents additional benefits of risk diversification for each outcome funder and can facilitate knowledge aggregation and the sharing of best practices.
Debt issuance: although most funding in a DIB is done by way of grant funding, there can be privately placed or public bonds and securities issued to raise funds. Driven by the need to increase the scalability of social impact investing, participants in the sector are increasingly developing structures involving debt issuances, thereby building more complex structures to access the loan or capital markets for funding. While this introduces additional costs and takes time to launch, the goal for market participants is to establish DIBs that can be marketed to institutional investors much like any capital markets offering.
Funding vehicles: an interesting recent development is the establishment of dedicated funding vehicles. Although such an approach may introduce additional complexity and higher costs, it can lead to efficiency both in time and money over the long term if the funding vehicle is to participate in multiple DIBs. For example, funding vehicles which provide for funding streams from different impact investments to be compartmentalised supports the scalability of DIBs, driving demand and increasing standardisation in structures and contractual documentation.
Conclusion
In order to deliver on the ambitious SDGs, the ever-expanding social impact investment market is driving new structures that “blend” philanthropic outcome based funding with private sector capital market techniques. Social impact enterprises that are looking to drive change and meet these SDGs are driving the demand for innovative and flexible funding structures in order to attract both private and philanthropic investors. A one-time establishment of a flexible funding structure can operate beyond a single impact investment and channel funding streams from multiple impact investments. As these methods mature and market participants are galvanised by positive results, we expect these funding structures to make their way into the consciousness of mainstream market participants.
Client Alert 2019-261
