What is a Social Impact Bond?
A social impact bond (also known as a social benefit good or social bond) is a type of financial security that provides capital to the public sector to fund projects that will create better social outcomes and lead to savings. These bonds are a new development in finance. UK-based Social Finance Ltd introduced the first social impact bond in 2010.
Purpose of Social Impact Bonds
The purpose of social impact bonds goes beyond its financial component. The securities are intended to help align the interests of different entities – including governments, investors, social enterprises, and the general public – to develop effective solutions for public-sector problems.
Although the security is called a bond, they lack most of the features of conventional bonds. They feature a fixed term, but they do not offer a fixed rate of return to investors. Instead, the repayment of the bonds primarily depends on the success of the project that has been subsidized using the bonds.
If a project is successful, the investors are repaid by the government using the savings that have been created by the project. However, if the project fails, the investors do not receive anything. Therefore, social impact bonds come with high risks for investors.
How Does a Social Impact Bond Work?
Social impact bonds are often differentiated from other fixed securities by the number of key players involved in the capital-raising process. The steps involved in the process include:
1. Identifying the problem and possible solutions
Generally, the process starts when the government identifies a challenge or problem in the public sector. Some of the problems include public safety, health, and family support services. Then, the government determines possible solutions to the identified problem, which can include a proven strategy or program that can be reproduced.
2. Raising funds for the project from private investors
After the potential solution has been identified, the government works to attract private investors to the project. The parties determine the quantifiable metrics that will indicate the project’s success.
Interested investors provide the required capital to support the operations and execution of the solution. Note that the investors do not receive any interest payments for the duration of the project.
3. Implementing the project
The project manager uses the obtained funds to finance the project’s operations, and the service provider begins the implementation of the program.
4. Assessing the project’s success and paying the project manager and investors
At the end of the fixed term, an independent evaluator completes the assessment of the project’s success based on the predetermined metrics. If the project meets the criteria, the government pays the project manager, who then transfers the funds to the investors in the social impact bonds.
Thank you for reading CFI’s explanation of social impact bonds. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
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