NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

In the non-profit and social sector the “new, new thing” is social impact bonds, also known as pay for success contracts. In the last two years, for example, the Stanford Social Innovation Review has published more than 50 articles about social impact bonds, and in 2011 the term was one of the top ten philanthropy buzzwords according to the Chronicle of Philanthropy.

Major players like McKinsey, Goldman Sachs and the Rockefeller Foundation have all jumped in. Huge numbers, like $600 billion of potential investment, get bandied about. All of which makes it sound like a great new source of financing except that only six deals have been financed. Is this a flash in the pan or the next big thing?

The Basic Concept

Social impact bonds bring together four parties – private investors, a knowledgeable intermediary, a government body and a social service provider. They create a contract in order to achieve a specific social outcome.

The social outcome for the first social impact bond involved reducing the 60 percent historical recidivism rate for prisoners. Under the terms of the contract, Social Finance (the intermediary) raised capital from foundations and high-net-worth individuals to fund nonprofit organizations who worked with the prisoners while they were in prison and after they got out. During the six year life of the contract, if these organizations can reduce the recidivism rate by at least 7.5 percent, the investors will receive their money back plus a return. For example, if the recidivism rate drops by 10 percent, the return would be 7.5 percent per year. If they have greater success, the return could be as much as 13 percent per year.