Social Impact Bonds (SIBs) are a new form of social-sector financing that have only recently emerged. These arrangements stipulate that private agents offer the principal investment in a social initiative and receive returns related to stated performance benchmarks. This presents an opportunity for the government to avoid footing the bill for expensive programs and for the private sector to support the social sector with the potential to profit. 

However, support for SIBs is far from unanimous. Although proponents argue passionately for their expansion, critics cite concerns such as risk, program implementation, and impact measurement. Both sides are fairly entrenched in their views, so the debate over this innovative instrument rages on.

The appeal of this method of social service financing is obvious. In theory, Social Impact Bonds allow the government to transfer the cost and risk of expensive social welfare programming to investors, who are incentivized to avoid losing their money - all at zero cost for taxpayers. 

Because SIBs are a relatively new form of investment, thorough measurements of its impact have yet to be published. Its proponents believe in 5 key advantages:

1. Prevention

By inviting the private sector, more funds become available for early intervention and preventative programming to address problems like homelessness.

2. Risk Transfer

The public sector shifts fiduciary responsibility to the private sector, with an investor base incentivized to maximize their results.

3. Innovation

Investors and service providers will strive to be as efficient and creative as they can. The greater margins they achieve on their outcomes, the larger the return on investment.

4. Performance Management

Businesses and foundations employ rigorous program monitoring and evaluation, expanding the knowledge base about which approaches are successful. By allowing SIBs to test what works, the government can funnel spending to cost-effective programs and enhance industry-wide awareness.

5. Collaboration

Each party involved in a Social Impact Bond - the government, private sector, service providers, inspection agencies, and more - constantly communicate and contribute to better outcomes across the board. By opening up investment and service provision to multiple networks, innovative new partnerships and streams of capital energize the social, educational, and healthcare sectors. 

In short, SIBs have the potential to bring a massive wave of financing to support innovative programs delivering social services in needed areas. By associating early-stage prevention with program efficiency, SIBs have special relevance to preventative intervention programs. They are an attractive solution to state and city governments under pressure to shrink budgets. The table below simplifies the value proposition for each party involved in a SIB:

Large as the appeal of Social Impact Bonds is, they’ve also attracted a fair amount of criticism. Arguments against SIBs are made on many fronts, ranging from practical concerns about implementation and investor risk to broader critiques of SIB’s role in the social service landscape.

Some skeptics allege that the need to budget money that would otherwise be spent on programs for monitoring and evaluation, middle management, and robust reporting dilutes available funds for the services themselves. Early returns on existing SIBs do not yet indicate that they out-perform NGOs and nonprofits in social impact. 

In fact, more than half of the world’s 151 SIBs “serve fewer than 480 people” each. If this model aims to appeal to more private investors (and community members), SIBs must demonstrate that their methods generate social impact more efficiently.

Additionally, SIBs set up to operate in developing countries or remote communities may encounter difficulties in obtaining consistent, reliable data. Many potential partners in such places lack robust M&E systems, accounting reports, and outcome measurement. In order to remain compliant, investors may unknowingly foot the bill for expensive, laborious infrastructure upgrades before thinking about their ROI.

Finally, SIBs are long and complicated legal agreements that take time, personnel, and extensive negotiations to materialize. As a result, slow timelines might scare away investors looking for a quick ROI.

In private investment, venture capitalists tend to seek “10x returns” and, often, equity in the organizations they fund. In the SIB model, they are highly unlikely to see either, which begs the question: why make an investment like this at all?

For one, many SIBs investors are motivated not just by the financial potential, but the social impact of their actions. Magnanimous as this base may be, however, the overwhelming majority of players in venture capital are quite interested in making money. For them, the idea of a high-risk, low-return, impact-based project might seem absurd.

The payout mechanisms for a social impact bond are activated when investors reach certain performance benchmarks. Often, these are concrete, demonstrable figures intended to paint a picture of the greater outcomes achieved through their work. 

Those in the impact investment space know that this is easier said than done. Quantifying social impact requires a progressive, innovative system for gathering, standardizing, and relaying data that many organizations lack. 

In the broader picture, industry preference for projects with easily-quantifiable metrics could obscure focus from deeper, structural problems that might be solved by short-term, private sector approaches. In other words, investors might prefer funding programs “that save money” rather than addressing complex social issues holistically.

Although the jury is out on the utility of SIBs to address inequality, they continue to present an attractive, cost-effective option for the social service finance sector. However, unless companies drastically improve their capacity for social impact measurement, the true effect of these initiatives remains unclear. The Environmental, Social, and Governance (ESG) ratings upon which many investors score themselves won’t suffice—ESG reporting by companies is neither “required, standardized nor audited”, and thus can’t tell us how SIBs generate impact as a whole. 

Although groups like the European Union have begun requiring all corporations to submit an annual impact report, the need for comprehensive impact measurement remains critical. Moving forward, measuring social impact will shift from the exception to the rule.